"What’s Your Fraud IQ? Think you
know enough about corruption to spot it in any of its myriad forms? Then rev up
your fraud detection radar and take this (deceptively) simple test." by Joseph
T. Wells, Journal of Accountancy, July 2006 ---
http://www.aicpa.org/pubs/jofa/jul2006/wells.htm

The Investor Protection Trust provides independent,
objective information to help consumers make informed investment decisions.
Founded in 1993 as part of a multi-state settlement to resolve charges of
misconduct, IPT serves as an independent source of non-commercial investor
education materials. IPT operates programs under its own auspices and uses
grants to underwrite important initiatives carried out by other
organizations.

For reasons that will be explained, the Court also
finds that BB&T is liable for tax penalties for its participation in the
STARS transaction. The conduct of those persons from BB&T, Barclays,
KPMG, and the Sidley Austin law firm who were involved in this and other
transactions was nothing short of reprehensible. Perhaps the business
environment at the time was “everyone else is doing it, why don’t we?”
Perhaps some of those who participated simply were following direction from
others. Nevertheless, the professionals involved should have known better
than to follow the STARS path, rife with its conflicts of interest,
questionable pro forma legal and accounting opinions, and a taxpayer with a
seemingly insatiable appetite for tax avoidance. One of Defendant’s experts,
Dr. Michael Cragg, aptly stated that “enormous ingenuity was focused on
reducing U.S. tax revenues.” Cragg, Tr. 4687. After wading through the
intricacies of the STARS transaction, the Court shares Dr. Cragg’s view that
“[t]he human effort, the amount of creativity and overall effort that was
put into this transaction . . . is a waste of human potential.”

Reports of fraud by corporate employees
have continued their ceaseless rise so far this year, according to the
Quarterly Corporate Fraud Index. The current drivers are increasing
awareness of fraud, mandated whistle-blower protections, and changing
company cultures.

The index measures reported frauds as a percentage
of all compliance-related reports. Most recently, for the second quarter
of 2012, that ratio climbed to 22.9%, up from 21.7% for the same quarter
in 2011.

“This index essentially has been going up since the day we started
tracking it [in 2005],” says Jimmy Lin, vice president of product
strategy and corporate development at The Network, a provider of
governance, risk, and compliance solutions that conducts the quarterly
analysis in conjunction with BDO Consulting. The index looks at
compliance-reporting activity at more than 1,400 clients of The Network
worldwide, including nearly half of the Fortune 500.

Corporate employees are simply becoming more aware of organizational
issues and more willing to report compliance errors, especially fraud,
Lin says. Fraud is more often covered in the news media these days, he
notes. Also, he claims, the client companies have become more
sophisticated in educating employees on what fraud looks like (which is
a service The Network provides). “We see the index going up and up as a
positive. Companies are getting more interested in a holistic approach
than a check-box approach to compliance.”

Employers are highly motivated to hear about alleged internal fraud
before an employee instead makes an initial report to the Securities and
Exchange Commission. “Even if it doesn’t turn into anything significant,
they want to catch wind of it first,” notes Lin. Companies know that
“even a hint of potential fraud issues in their organization, whether
true or not,” puts their reputation at risk, not only with the public
but also internally: “Employees may begin to wonder about the company’s
ethics.”

The whistle-blower protections under the Dodd-Frank Act, such as
prohibiting retaliation against whistle-blowers, also may be having an
impact. Companies are “couching it as building a better culture,” says
Lin.

Jonny Frank, a partner at forensic-accounting firm StoneTurn Group,
points out that the SEC has offered incentives to encourage employees to
use company-compliance hotlines. But another reason for the upward trend
may be that the government expects companies to make the hotlines
accessible to such third parties as customers and suppliers, as well as
to employees.

And a growing number of companies annually require employees to
certify as to their knowledge of wrongdoing. “It’s one thing to put the
burden on employees to come forward; it’s another to ask them to confirm
they don’t know of any wrongdoing,” Frank says. That trend “suggests a
culture where employees see that the company is serious and not just
giving lip service to fraud.”

Frank says compliance officers generally are doing a good job of
pushing that message. Unfortunately, he adds, some companies’ finance
teams are getting less involved as ethics and compliance controls
mature. “It becomes easier for the CFO to just hand off that
responsibility to compliance.”

Lin observes that organizations are vulnerable if compliance
enforcement is not a pervasive theme throughout the company. If
functional areas, departments, and divisions aren’t working together to
make sure fraud is addressed, “then everybody is going to lose,” he
says.

Jensen Comment
I know a Professor X who used to do something similar. Nearly 80% of his
students had an A grade going into the final. On the last day of class he handed
out teaching evaluations --- well in advance of the final examination scheduled
late in final exam week. Then in the the final exam he clobbered them with an
exam that made them happy to pass the course with any grade.

Of course, there's a difference between Professor X versus the colleges that
report incomplete applications as full applications in computing admission
acceptance rates. In the case of Professor X it did not take many semesters for
it to become widely known across campus how he was shrinking the number of top
grades in his courses. In the case of W&L and other colleges shrinking
acceptance rates it might never have become known by the media how these
colleges were fudging their acceptance rates.

Abstract:
A most unlikely collection of suspects - law schools, their deans, U.S. News
& World Report and its employees - may have committed felonies by publishing
false information as part of U.S. News' ranking of law schools. The possible
federal felonies include mail and wire fraud, conspiracy, racketeering, and
making false statements. Employees of law schools and U.S. News who
committed these crimes can be punished as individuals, and under federal law
the schools and U.S. News would likely be criminally liable for their
agents' crimes.

Some law schools and their deans submitted false
information about the schools' expenditures and their students'
undergraduate grades and LSAT scores. Others submitted information that may
have been literally true but was misleading. Examples include misleading
statistics about recent graduates' employment rates and students'
undergraduate grades and LSAT scores.

U.S. News itself may have committed mail and wire
fraud. It has republished, and sold for profit, data submitted by law
schools without verifying the data's accuracy, despite being aware that at
least some schools were submitting false and misleading data. U.S. News
refused to correct incorrect data and rankings errors and continued to sell
that information even after individual schools confessed that they had
submitted false information. In addition, U.S. News marketed its surveys and
rankings as valid although they were riddled with fundamental methodological
errors.

The show-horse set will descend on this small city
this month to bid on the crown jewel of what federal authorities allege to
be a massive fraud: Hundreds of top-ranked quarter horses amassed by the
former city comptroller accused of stealing tens of millions of dollars from
public coffers.

Rita Crundwell, 59 years old, was arrested by
federal authorities in April and accused of stealing more than $53 million
from this city of 15,700 whose finances she ran since the 1980s.

Federal authorities said the alleged theft took
place starting in 1990, and say that Ms. Crundwell, whose salary was around
$80,000, also used the allegedly pilfered funds to buy sports cars, a boat,
a home in Florida and a $2 million motor home.

Ms. Crundwell has pleaded not guilty to one charge
of wire fraud. After her arrest, she was released from federal custody and
is scheduled to appear in U.S. District Court in Rockford, Ill., in October.
She declined to comment through her lawyers.

Authorities say that Ms. Crundwell used the
allegedly stolen funds to furnish a horse ranch that housed nearly 400
quarter horses with names like Have Faith in Money, Jewels by Tiffany, and
Secure with Cash.

Ms. Crundwell worked for the city nearly all her
life, becoming comptroller in 1983. Over the years, she also became known as
a renowned breeder of horses that she bought and sold and showed. The
government also is auctioning other of her assets, including the motor home
and horse equipment.

Authorities say Ms. Crundwell no longer can afford
the $200,000 a month required to care for all the horses.

Ms. Crundwell agreed to the sale, authorities say,
which was ordered through a court process. Federal authorities believe that
horses were purchased and possibly maintained with funds from the alleged
fraud. Money from the auction eventually could go to Dixon as partial
restitution, but proceeds will be held in escrow until the case concludes.

Auctioneers said the size of the horse sale by a
single owner is rare. A spokesman for the American Quarter Horse Association
said the high caliber of the horses also makes it extraordinary.

"In all my years in the business, we've never done
anything quite like this," said Mike Jennings, a four-decade veteran of the
horse-auction business who the government hired to oversee the Crundwell
sale, scheduled to take place on Sept. 23 and 24, and online starting last
Friday, though no sales will take place until this week.

More than a thousand bidders, bargain hunters and
onlookers are expected to attend the auction. Hotels in Dixon are sold out
for the auction weekend, and city officials plan to run buses between
downtown and the Crundwell ranch about four miles away.

Ms. Crundwell built her empire on a horse farm here
known as the RC Ranch. Her initials are on the peak of the main barn and in
mosaic on the tile floor of her trophy room, where hundreds of ribbons and
horse statuettes are displayed.

On the walls are poster-size photographs of Ms.
Crundwell, often in a white cowboy hat, showing her horses. She excelled in
the beauty event known as halter, and holds more world championships than
any other amateur owner. Eight years in a row, she was crowned top owner at
the world championship show in Oklahoma City.

Ms. Crundwell also was popular with some on the
circuit. She sponsored events, rented stalls at shows, and hired trainers
and other staff. "For years, people felt they weren't able to compete
against Rita and stopped trying," said Amy Gumz, owner of Gumz Farms in
western Kentucky.

Ms. Crundwell's exit appears to be sparking new
interest in the events she once dominated. That could help fuel demand at
the upcoming auction where Mr. Jennings, the auctioneer, said the top horses
could fetch hundreds of thousands of dollars.

The quarter horse is the U.S.'s most popular breed,
used widely for trail riding, ranching and equestrian events. The breed is
also trained to race short distances—its name comes from the quarter-mile
that quarter horses typically run. The competitive show world ranges from
cowboys riding them to rope cattle, to muscular horses being paraded in a
ring and judged on their beauty.

In Dixon, Ms. Crundwell's hometown, many residents
remain baffled by her arrest, which came after a colleague filling in while
she was on vacation spotted alleged irregularities in the accounts. Dixon
Mayor Jim Burke said because of the size and success of her horse operations
Dixonites believed Ms. Crundwell's booming horse business financed her
lifestyle.

Dixon officials expect the auction to net several
million dollars, which they hope will eventually end up with the city. Mr.
Burke would like to use auction proceeds to pay off municipal debt and
possibly to give residents rebates on water or other municipal bills.

Rita Crundwell has been the CFO/comptroller of
Dixon, Illinois since the 1980s; a typical tenure for even an unelected
Illinois official. In those 30-ish years, it appears that she performed her
duties adequately enough, but she was just put on unpaid leave. You see, at
some point in 2006, it is alleged that Ms. Crundwell started helping herself
to money that belonged to the citizens of
Ronald Reagan's boyhood home. Prosecutors allege
that this went for the last six years and that
Crundwell made offwith $30,236,503 (and 51¢).

Federal agents served warrants and seized
contents of her bank accounts, seven trucks and trailers, a $2 million
motor home and a Ford Thunderbird—all of which prosecutors allege were
paid for with money taken from city bank accounts by Crundwell.
[...] Bank records obtained by the FBI allegedly show Crundwell
illegally withdrew $30,236,503 from Dixon accounts since July 2006 ,
money she used, among other things, to buy a 2009 Liberty Coach Motor
home for $2.1 million; a tractor truck for $147,000; a horse trailer for
$260,000; and $2.5 million in credit card payments for items that
included $340,000 in jewelry.

So a decent haul, but a Ford Thunderbird?
Good Christ, spring a bit for the Lincoln Continental at least. Questionable
taste in automobiles aside, one can't help but wonder how Dixon - a city
with a population of just ~15,000 - could not notice millions of dollars
missing. But they did! It's strange because in a city of that size, people
gossip about one another's $35 overdraft fees, never mind millions of
dollars being spent on multi-million dollar motorhomes. Anyway, Crundwell
(who has a thing for horses apparently) had a good thing going, but then
made the mistake of taking a little extra vacation:

[L]ast year she took an additional 12 weeks of
unpaid vacation. A city employee substituting for Crundwell examined
bank statements and notified the mayor of activity in an account that,
according to the complaint, he didn't know existed. Bank records list
the primary account holder as the City of Dixon. An entity named RSCDA
also is named on the account, with checks written on the account more
expansively identifying that second account holder as "R.S.C.D.A., C/O
Rita Crundwell."

So basically the city discovere the missing cash by
the virtue of dumb luck, which sometimes is what it takes for these things
to get uncovered. Betterlate than, oh
whatever... seriously, a Thunderbird?

More Clever than the Thumb of a Butcher
September 21, 2012 message from Dan Stone

One semester, I used the news story at the end of
this post in an accounting systems class. I thought it was a clever, funny
example of a failure of accounting controls. As was evident from my student
evaluations, many students were not amused. I have since learned that, at
least in Kentucky, anything related to sex or body functions -- even if
relevant to the class -- must not be spoken about.

Dan Stone

Title: Co-op apologises after shopper is
overcharged because store assistant's breasts were resting on the scales

A supermarket customer was over-charged by
around £5 while buying fruit and vegetables because the cashier's
breasts were resting on the weighing scales.

Bosses at a Jersey branch of Co-operative
explained that the mistake occurred because the shop assistant's seat
had been too low, causing her to lean on the counter.

Jim Hopley, chief executive of Channel Islands
Co-operative, said the money has now been refunded and admitted that he
has never seen anything like it in his 40 years of retail experience.

Rachael Martin, who has an eight-year-old son, told
police she could afford her lifestyle by working as a 'common prostitute'
but later admitted to thefts Underwent complete body overhaul in just weeks,
including £4,000 on breast surgery, £1,700 on dental surgery, and
liposuction She also spent £670 at exclusive jewellers Tiffany, and £506 on
a pair of Jimmy Choo shoes The law graduate was jailed for 52 weeks

The Pentagon ordered 1,500 Turkeys for Thanksgiving
The expensive luxury and heavy Chevy Volt is a turkey and less environmentally
friendly than hybrid cars of competitors (because of low gas mileage and
miniscule electric power range). It appears that it's only customer is, get
this, the Pentagon that just ordered 1,500 Volts.

Is the Chevy Volt losing $49,000 on each model built?
Not any longer thanks to the Pentagon.

In 2009, the Presidential Task Force on the Auto
Industry said that "GM is at least one generation behind Toyota on advanced,
“green” powertrain development. In an attempt to leapfrog Toyota, GM has
devoted significant resources to the Chevy Volt." and that "while the Chevy
Volt holds promise, it is currently projected to be much more expensive than
its gasoline-fueled peers and will likely need substantial reductions in
manufacturing cost in order to become commercially viable." A 2009 Carnegie
Mellon University study found that a PHEV-40 will be less cost effective
than a HEV or a PHEV-7 in all of the scenarios considered, due to the cost
and weight of the battery Jon Lauckner, a Vice President at General Motors,
responded that the study did not consider the inconvenience of a 7 miles (11
km) electric range and that the study's cost estimate of US$1,000 per kWh
for the Volt's battery pack was "many hundreds of dollars per kilowatt hour
higher" than what it costs to make today." President Barack Obama behind the
wheel of a new Chevy Volt during his tour of the General Motors Auto Plant
in Hamtramck, Michigan

In early 2010, it was reported that General Motors
would lose money on the Volt for at least the first couple of generations,
but it hoped the car would create a green image that could rival the Prius.

After the Volt's sales price was announced in July
2010, there was concern expressed of the launch price of the Volt and its
affordability and resulting popularity, especially when the federal
subsidies of US$2.4 billion were taken into account in the development of
the car.

General Motors CEO Edward Whitacre Jr. rejected as
"ridiculous" criticism that the Volt's price is too expensive. He said that
"I think it's a very fair price. It's the only car that will go coast to
coast on electricity without plugging it in, and nobody else can come
close." Despite the federal government being the major GM shareholder due to
the 2009 government-led bankruptcy of the automaker, during a press briefing
at the White House a Treasury official clarified that the federal government
did not have any input on the pricing of the 2011 Chevrolet Volt.

There have also been complaints regarding price
markups due to the initial limited availability in 2010 of between US$5,000
to US$12,000 above the recommended price,[232] and at least in one case a
US$20,000 mark up in California.[233] Even though the carmaker cannot
dictate vehicle pricing to its dealers, GM said that it had requested its
dealers to keep prices in line with the company’s suggested retail price.

In May 2011 the National Legal and Policy Center
announced that some Chevrolet dealers were selling Volts to other dealers
and claiming the US$7,500 federal tax credit for themselves. Then the
dealers who bought the Volts sell them as used cars with low mileage to
private buyers, who no longer qualify for the credit. General Motors
acknowledged that 10 dealer-to-dealer Volt sales had taken place among
Chevrolet dealers, but the carmaker said they do not encourage such
practice.

In September 2012, Reuters published an
opinion/editorial article where it claimed that General Motors, nearly two
years after the introduction of the car, was losing $49,000 on each Volt it
built. The article concludes that the Volt is "over-engineered and
over-priced" and that its technological complexity has put off many
prospective buyers, due to fears the car may be unreliable. GM executives
replied that Reuters' estimates were grossly wrong as they allocated the
production costs only on the number of Volts sold instead of spreading the
production costs in the future, over the entire lifetime of the model. GM
explained that the investments will pay off once the innovative technologies
of the Volt will be applied across multiple current and future products

So reads a sign outside a small roadside craft
store in Utah. The message is clearly tongue-in-cheek. But if it hung next
to the corporate offices of some of our nation's big financial institutions
or auto makers, there would be no irony in the message at all.

It shouldn't surprise us that the role of American
business is increasingly vilified or viewed with skepticism. In a Rasmussen
poll conducted this year, 68% of voters said they "believe government and
big business work together against the rest of us."

Businesses have failed to make the case that
government policy—not business greed—has caused many of our current
problems. To understand the dreadful condition of our economy, look no
further than mandates such as the Fannie Mae and Freddie Mac "affordable
housing" quotas, directives such as the Community Reinvestment Act, and the
Federal Reserve's artificial, below-market interest-rate policy.

Far too many businesses have been all too eager to
lobby for maintaining and increasing subsidies and mandates paid by
taxpayers and consumers. This growing partnership between business and
government is a destructive force, undermining not just our economy and our
political system, but the very foundations of our culture.

With partisan rhetoric on the rise this election
season, it's important to remind ourselves of what the role of business in a
free society really is—and even more important, what it is not.

The role of business is to provide products and
services that make people's lives better—while using fewer resources—and to
act lawfully and with integrity. Businesses that do this through voluntary
exchanges not only benefit through increased profits, they bring better and
more competitively priced goods and services to market. This creates a
win-win situation for customers and companies alike.

Only societies with a system of economic freedom
create widespread prosperity. Studies show that the poorest people in the
most-free societies are 10 times better off than the poorest in the
least-free. Free societies also bring about greatly improved outcomes in
life expectancy, literacy, health, the environment and other important
dimensions.

So why isn't economic freedom the "default setting"
for our economy? What upsets this productive state of affairs? Trouble
begins whenever businesses take their eyes off the needs and wants of
consumers—and instead cast longing glances on government and the favors it
can bestow. When currying favor with Washington is seen as a much easier way
to make money, businesses inevitably begin to compete with rivals in
securing government largess, rather than in winning customers.

We have a term for this kind of collusion between
business and government. It used to be known as rent-seeking. Now we call it
cronyism. Rampant cronyism threatens the economic foundations that have made
this the most prosperous country in the world.

We are on dangerous terrain when government picks
winners and losers in the economy by subsidizing favored products and
industries. There are now businesses and entire industries that exist solely
as a result of federal patronage. Profiting from government instead of
earning profits in the economy, such businesses can continue to succeed even
if they are squandering resources and making products that people wouldn't
ordinarily buy.

Because they have the advantage of an uneven
playing field, crony businesses can drive their legitimate competitors out
of business. But in the longer run, they are unsustainable and unable to
compete internationally (unless, of course, the government handouts are big
enough). At least the Solyndra boondoggle ended when it went out of
business.

By subsidizing and mandating politically favored
products in the energy sector (solar, wind and biofuels, some of which
benefit Koch Industries), the government is pushing up energy prices for all
of us—five times as much in the case of wind-generated electricity. And by
putting resources to less-efficient use, cronyism actually kills jobs rather
than creating them. Put simply, cronyism is remaking American business to be
more like government. It is taking our most productive sectors and making
them some of our least.

The effects on government are equally
distorting—and corrupting. Instead of protecting our liberty and property,
government officials are determining where to send resources based on the
political influence of their cronies. In the process, government gains even
more power and the ranks of bureaucrats continue to swell.

Subsidies and mandates are just two of the
privileges that government can bestow on politically connected friends.
Others include grants, loans, tax credits, favorable regulations, bailouts,
loan guarantees, targeted tax breaks and no-bid contracts. Government can
also grant monopoly status, barriers to entry and protection from foreign
competition.

Whatever form these privileges take, Americans are
rightly suspicious of the cronyism that substitutes political influence for
free markets. According to Rasmussen, two-thirds of the electorate are
convinced that crony connections explain most government contracts—and that
federal money will be wasted "if the government provides funding for a
project that private investors refuse to back." Some 71% think "private
sector companies and investors are better than government officials at
determining the long-term benefits and potential of new technologies." Only
11% believe "government officials have a better eye for future value."

Former Detroit Mayor Kwame Kilpatrick conspired
with his father and best friend to turn City Hall into a den of bribes and
kickbacks, a prosecutor said Friday as jurors heard opening statements in
Kilpatrick's corruption trial.

Assistant U.S. Attorney Mark Chutkow gave jurors a
40-minute overview of what they'll see and hear in the months ahead. He said
Kilpatrick was an enthusiastic rising star in Michigan politics who moved
from the state Legislature, then enriched himself with hundreds of thousands
of dollars by muscling contractors, fooling political supporters and rigging
city business.

"This was not politics as usual," Chutkow said.
"This was extortion, bribery, fraud. ... They broke their oath to serve this
city. It was the citizens of the city of Detroit who were left holding the
short end of the stick."

Kilpatrick -- who quit office in 2008 in an
unrelated scandal and eventually served more than a year in prison for a
probation violation -- is charged with racketeering conspiracy, extortion,
bribery, fraud, false tax returns and tax evasion. His father, Bernard, also
is on trial, along with the ex-mayor's best friend, Bobby Ferguson, and
former Detroit water boss Victor Mercado.

Chutkow described how Kilpatrick deposited more
than $200,000 in cash in his bank account and paid his credit card bills
with another $280,000 in cash.

"He no longer lived like the citizens he governed,"
the prosecutor said, Advertisement noting luxurious travel and custom-made
suits.

The outgoing deputy speaker of the Rhode Island
House and a business partner have agreed to plead guilty to conspiracy and
tax fraud for cheating the federal government out of more than $500,000 in
tax payments, federal prosecutors said Friday.

Rep. John McCauley Jr., a Democrat who represents
Providence, was charged Friday in federal court along with William L'Europa,
his partner in their insurance adjuster business. Both indicated in court
filings that they plan to plead guilty. The men were charged with conspiracy
to defraud the United States and filing false tax returns.

McCauley is the sixth Rhode Island lawmaker to face
criminal charges in the past year.

Prosecutors said McCauley and L'Europa
underreported nearly $1.8 million dollars in receipts for tax years 2007 to
2010. They face up to eight years in prison.

McCauley, 54, was first elected in 1990 and is not
seeking re-election. He didn’t immediately return a message left at his
home. No one answered a phone listing for L'Europa.

Federal agents raided McCauley and L'Europa’s
office in November and seized several boxes. They later said the search was
part of an investigation into an arson fraud. Louisa Knight later pleaded
guilty to federal fraud charges after admitting setting fire to her home and
later filing an insurance claim. Authorities said at the time there was no
indication that McCauley or L'Europa knew about the fraud.

A spokesman for Rhode Island U.S. Attorney Peter
Neronha wouldn’t comment on whether the new charges are related to that
investigation.

House Speaker Gordon Fox issued a statement Friday
saying that the charges against McCauley had ‘‘nothing to do with his role
at the Statehouse’’ and that McCauley has taken responsibility in
‘‘addressing his personal issues.’’

‘‘He has been a long-time friend who always
represented his district well,’’ said Fox, D-Providence.

Five other lawmakers have faced criminal charges in
the past year.

State Sen. Majority Leader Dominick Ruggerio,
D-North Providence, was charged with driving under the influence in April,
but the charge was dropped when Ruggerio admitted refusing an alcohol test
and agreed to perform community service. His license was suspended for six
months.

Rep. Robert Watson, R-East Greenwich, was charged
with marijuana possession and DUI in April in Connecticut and was arrested
in Rhode Island in January on a charge of marijuana possession. The former
House minority leader pleaded not guilty to charges from the first incident
and pleaded no-contest to the more recent charge. He is not seeking
re-election.

Police arrested Rep. Dan Gordon, R-Portsmouth, in
September after learning that he faced charges in Massachusetts that he
failed to stop for police and drove with a suspended license stemming from a
2008 traffic stop. Gordon agreed to pay $1,000 to resolve the evasion charge
and received probation for other traffic charges. He is not seeking
re-election.

Rep. Leo Medina, D-Providence, was charged last
month with practicing law without a license. Not guilty pleas were entered
on his behalf. He is also accused of pocketing proceeds from a life
insurance policy on a friend’s deceased daughter. Medina pleaded not guilty
to those charges. He was defeated in this week’s Democratic primary.

In January, prosecutors dismissed a sexual assault
case against Rep. John Carnevale, D-Providence, after the accuser died of
medical causes. He had pleaded not guilty.

Last week Mr. Zakaria apologized "unreservedly" to
New Yorker writer Jill Lepore after a blogger noticed that a
paragraph in his Time column was all-but identical to something Ms. Lepore
had written. Mr. Zakaria has now been given a month's suspension by his
employers pending further review of his work.

We'll see if there are other shoes to drop. Among
the more mystifying aspects of this story is that plagiarism in the age of
Google is an offense hiding in plain sight, especially when the kind of
people who read Mr. Zakaria's columns are the same kind of people who read
the New Yorker. Why couldn't he have added the words, "As the New Yorker's
Jill Lepore wrote . . ."? What could he possibly have been thinking?

My guess is he wasn't thinking. That's never a good
thing, but it's something that might happen to an overcommitted journalist
so constantly in the public eye that he forgets he's there. The proper
response is the full apology he has already made, and maybe a
reconsideration of whether the current dimensions of Fareed Zakaria Inc. are
sustainable. Otherwise, end of story.

But that's not how Mr. Zakaria is being treated. To
some of his critics, nothing less than the Prague Defenestration will do.

Here, for instance, is Jim Sleeper in the
Huffington Post—a publication that earns much of its keep piggybacking on
the work of others. "Zakaria is a trustee of Yale," notes Mr. Sleeper. "If
the Yale Corporation were to apply to itself the standards it expects its
faculty and students to meet, Zakaria would have to take a leave or resign."

Mr. Sleeper, a one-time tabloid columnist, goes on
to impugn Mr. Zakaria for various offenses, such as dissing people Mr.
Sleeper obviously likes and commanding speaking fees Mr. Sleeper seems to
think are too high. If Mr. Sleeper has ever been offered $75,000 to deliver
deep thoughts to a corporate board and turned the money down, it would be
interesting to see the evidence. Otherwise, his is the most vulgar voice of
envy.

Also gloating are the people who detest Mr. Zakaria
for his views. In a recent column in Reason magazine, Ira Stoll—who often
insinuates that this editorial page gets all its good ideas from him—more or
less gives Mr. Zakaria a plagiarism pass, then lights into him for holding
incorrect views on tax rates and the Middle East. Who knew that disagreeing
with Ira Stoll was one of the world's greatest journalistic offenses?

I'm an occasional guest on Mr. Zakaria's show, for
which I get no pay and not much glory. Mr. Zakaria and I have an amicable
relationship but have never socialized. And my political views are
considerably to the right of his, to say the least.

But I will give Mr. Zakaria this: He anchors one of
the few shows that treats foreign policy seriously, that aims for an honest
balance of views, and that doesn't treat its panelists as props for an
egomaniacal host. He's also one of the few prominent liberals I know who's
capable of treating an opposing point of view as something other than a slur
on human decency.

In my book, that makes him a good man who's made a
mistake. No similar compliment can be paid to the schadenfreude brigades now
calling for his head.

'If you knew how I work!" Balzac wrote to a friend
in 1832 as he finished up another volume of what would become the "Comédie
humaine." "I am a galley slave to pen and ink, a true dealer in ideas." Dave
Tomar is no stranger to the feeling of tortured subjugation to the written
word, though whether one could justly call him a "dealer in ideas" is
another matter—"counterfeiter" is more like it.

In "The Shadow Scholar: How I Made a Living Helping
College Kids Cheat," Mr. Tomar, a 32-year-old Rutgers graduate, describes
how, for the better part of a decade, he labored as a writer-for-hire
catering to incompetent and lazy students. It didn't matter if the task at
hand was a reflection on Nietzsche, a piece on Piaget's theory of genetic
epistemology, or a 150-page paper on public-sector investment in China and
India. Mr. Tomar, with not a small amount of help from Wikipedia, was a man
for all semesters.

The most amusing and disturbing tidbits of "The
Shadow Scholar" are excerpted communiqués from Mr. Tomar's clients that show
just how badly these arrested young minds required his assistance. "Let me
know what will the paper going to be about," one college student instructs
Mr. Tomar. "Also dont write about, abortion, euthanasia, clothing or death
penalty, yhose were not allowed by my teacher."

Mr. Tomar worked for only a few cents a word, but
he kept busy enough to earn $66,000 in 2010. (Not bad, especially
considering that the average pay for a non-tenure-track lecturer at Harvard
last year—an institution with its own student-plagiarism scandal at the
moment—was just under $57,000.) He was a freelancer for several of the
"hundreds and possibly thousands" of online paper mills in the United
States, services with names like rushessay.com and college-paper.org that
produce custom essays for their student clients. Lest you think that this
sleazy racket is a fringe, underground phenomenon, Mr. Tomar is here to
declare otherwise: "It's mainstream. It's popular culture. It's taxable
income. It's googleable."

"The Shadow Scholar" is a follow-up to a 2010 essay
of the same name that Mr. Tomar wrote, under the pseudonym Ed Dante, for the
Chronicle of Higher Education. The original essay was concise, hard-hitting
and topical, revealing the dirty details of a business that educators try
studiously to ignore. By contrast, Mr. Tomar's book is frequently
self-indulgent and meandering, as much a memoir of the author's post-college
search for purpose as a whistleblowing manifesto. Clichés and mixed
metaphors abound: "I'm tumbling into a well of bad memories the way that a
motorcycle backfiring in the distance might take a guy back to 'Nam," he
tells us in an eight-page account of a phone call to the Rutgers Parking and
Transportation Department.

For those willing to wade through it, however, "The
Shadow Scholar" is a fascinating exposé of the remarkably robust industry of
academic ghostwriting. Assuming that Mr. Tomar's story is at least roughly
faithful to the truth, his testimony amounts to a harrowing indictment of
the modern American university's current shortcomings as a meritocratic,
credentializing institution, much less a home for mental and moral growth.

Mr. Tomar didn't just aid and abet casual cheating.
Rather, he claims, he was engaged in a process of systemic intellectual
fraud that students took advantage of all the way up the academic ziggurat:
fabricating "personal statements" for unqualified college applicants;
crafting term papers for undergraduates and "cockpit parents" who diligently
directed their children's plagiarism; sweating over doctoral dissertations
with only one page of instructions to go on; even, in one extraordinary
case, doing the writing for an entire Ph.D. program in cognitive and
behavioral psychology on someone else's behalf.

Mr. Tomar's dispatches from the dark side certainly
do nothing to dispel the impression that, even as tuition hikes at many
colleges outpace inflation, American colleges and universities may be
delivering a product of declining value. Former Emory University president
William Chace, in a recent essay on the normalization of cheating in the
academy, wrote of a "suspicion that students are studying less, reading
less, and learning less all the time." The numbers back this up. Economists
Philip Babcock and Mindy Marks reported in 2010 that the number of hours
that full-time college students spent on their studies dropped by a third
between 1961 and 2003, to 27 hours per week from 40.

Having largely abandoned the mission of molding
student character, many American universities and colleges today find
themselves challenged to uphold the most minimal standards of technical
training and assessment. Sociologists Josipa Roksa and Richard Arum, in
their 2011 book "Academically Adrift," found that, of a nationally
representative sample of thousands of college students, over a third
demonstrated "no significant progress on tests of critical thinking, complex
reasoning and writing" after four years in college. Unable or unwilling to
do the work, many students find it far easier to hand it off to a
subcontractor.

Continued in article

Jensen Comment
Dave Tomar is now a student in the Yale Law school. He hopes that his extensive
experience in cheating will make him a successful lawyer.

SUMMARY: The trial against former UBS trader Kweku Adoboli began on
Monday. "The U.K. prosecutors opened their case...by casting the 32-year-old
as the lone perpetrator of an illegal scheme that shook the Swiss bank last
year." The related video comments on the reputational impact of the $2.3
billion trading loss generated by one "desk" being indicative of
insufficient internal controls. "Mr. Adoboli sat on a desk trading exchange
traded funds...his fraudulent activity began in 2008 when he suffered a
$400,000 loss on a legitimate trade and subsequently booked a false trade to
hide it."

CLASSROOM APPLICATION: The article may be used to discuss internal
control and material weaknesses, fraudulent accounting and reporting, and
ethics.

QUESTIONS:
1. (Introductory) For how long did Mr. Kweku Adoboli book false
trades to cover losses he did not want exposed? What was his apparent reason
for these actions?

2. (Introductory) How was Mr. Adoboli able to avoid detection of
his false accounting? In your answer, define the term "umbrella" account.

3. (Advanced) Identify one internal control that should catch false
entries such as those made by Mr. Adoboli.

4. (Advanced) What was the impact on the UBS AG stock price when
the scandal about Mr. Adoboli broke in 2011? Does this reaction merely
reflect the losses incurred by Mr. Adoboli or something more? Explain.

U.K. prosecutors opened their case in the trial of
Kweku Adoboli, the former UBS AG trader accused of a $2.3 billion fraud, by
casting the 32-year-old as the lone perpetrator of an illegal scheme that
shook the Swiss bank last year.

One year to the day after the scandal began to
erupt, Mr. Adoboli sat in a packed London courtroom as Sasha Wass of the
Crown Prosecution Service depicted him as a reckless and greedy fraudster
bent on boosting "his bonus, his status, his job prospects and his ego."

The defense didn't provide any indication of its
arguments in court, but Ms. Wass said Mr. Adoboli will claim that three of
his colleagues on his trading desk were aware of his illegal activity before
it surfaced.

Mr. Adoboli, who faces two counts each of false
accounting and fraud, has pleaded not guilty. If convicted, he faces up to
10 years in jail on each fraud charge and seven years on each accounting
charge. He is currently free on bail.

For UBS, the trial could shed an uncomfortable
light on how a relatively junior trader could have caused the largest
unauthorized trading loss in U.K. history, despite the giant bank's
sophisticated risk controls.

The case comes on the heels of a series of scandals
across the financial sector that have inflamed public opinion, particularly
in Europe.

Beginning in 2006, Mr. Adoboli sat on a desk at UBS
focused on trading exchange-traded funds, which are mutual-fund-like
investments, often tied to well-known indexes like the Standard & Poor's
500-share index, but which trade on exchanges throughout the day. According
to prosecutors, Mr. Adoboli's fraudulent activity began in 2008, when he
suffered a $400,000 loss on a legitimate trade, and subsequently booked a
false trade to hide it.

He was able to hide his unauthorized trades for
years, using hundreds or thousands of fake accounting entries and so-called
"umbrella" accounts where he stowed funds, until market turmoil last summer
caused his losses to balloon and ultimately tripped internal compliance
alarms, according to the picture painted by the prosecution.

The unauthorized trades eventually cost the bank
$2.3 billion.

The contours of the positions that the prosecution
and defense will likely stake out in the eight-week trial began to come into
focus on the first day of the proceedings. The prosecution will begin
calling witnesses on Monday, starting with an expert on bank trading.

Ms. Wass, the prosecutor, argued that Mr. Adoboli
acted alone, apparently trying to pre-empt an argument that others knew of
his illegal actions.

She repeatedly read from a lengthy email Mr.
Adoboli allegedly sent to colleagues on Sept. 14, 2011, the day before UBS
disclosed the unauthorized trading loss. In that email, he allegedly said:
"It is with great stress that I write this mail. First of all the ETF trades
that you see on the ledger are not trades that I have done with a
counterparty as I previously described."

The prosecution played recordings of conversations
between Mr. Adoboli and colleagues who quizzed him on his trades in August
and September of last year, in which the former trader attempts to explain
them.

Mr. Adoboli, dressed in a grey suit, white shirt
and maroon patterned tie, sat impassively as Ms. Wass laid out the
prosecution's case, at times playing with a pen and at others conferring
with his lawyer.

The prosecution depicted an ambitious young banker
who started out in UBS's so-called "back office" processing trades, and
later moved to the more lucrative and prestigious trading floor, using
knowledge he gained from his prior job to obfuscate his alleged illegal
activity. He went from earning £40,500 ($65,788) in salary and bonus in 2005
to £360,000 in 2010, which included a £250,000 bonus that prosecutors said
was boosted by his illegally inflated results.

"Like most gamblers, he believed he had the magic
touch. Like most gamblers, when he lost, he caused chaos and disaster to
himself and all of those around him," Ms. Wass said.

The trading loss proved devastating for UBS. The
bank was already under pressure because of a massive credit loss it suffered
at the height of the financial crisis that resulted in the need for
government aid as well as from persistently weak business conditions in the
securities industry since then.

The scandal initially knocked 10% off the bank's
already beleaguered stock, ate into its bonus pool and forced the
resignation of its chief executive, Oswald Grübel.

Below is the text of an e-mail former UBS AG (UBSN)
trader Kweku Adoboli sent to bank accountant William Steward on Sept. 14,
2011, describing how he accrued trading losses.

The e-mail was read out by prosecutor Sasha Wass at
Adoboli’s fraud trial in London today.

The subject line for the e-mail, sent from
Adoboli’s home e-mail account, was: “An explanation of my trades.”

Dear Will,

It is with great stress that I write this mail.
First of all the ETF (Exchange Traded Funds) trades that you see on the
ledger are not trades that I have done with a counterparty as I
previously described.

I used the bookings as a way to suppress the
PnL losses that I have accrued through off-book trades that I made.
Those trades were previously profit making, became loss making as the
market sold off aggressively though the aggressive sell-off days of July
and early August.

Initially, I had been short futures through
June and those lost money when the first Greek confidence vote went
through in mid-June. In order to try and make the money back I flipped
the trade long through the rally.

Although I had a couple of opportunities to
unwind the long trade for a negligible loss, I did not move quickly
enough for the market weakness on the back of the first back macro data
and then an escalation Eurozone crisis cost me the losses you will see
when the ETF bookings are cancelled. The aim had been to try and make
the money back before the September expiry date came through but I
clearly failed.

These are still live trades on the book that
will need to be unwound. Namely a short position in DAX futures [which
had been rolled to December expiry] and a short position in S and P 500
futures that are due to expire on Friday.

I have now left the office for the sake of
discretion. I will need to come back in to discuss the positions and
explain face to face, but for reasons that are obvious, I did not think
it wise to stay on the desk this afternoon.

I will expect that questions will be asked as
to why nobody else was aware of these trades. The reality is that I have
always maintained that these were EFP trades to the member of my team,
BUC, trade support and John Di Bacco (Adoboli’s manager).

I take full responsibility for my actions and
the stilt storm that will now ensue. I am deeply sorry to have left this
mess for everyone and to have put my bank and my colleagues at risk.

Quarterback Vince Young has been ordered to pay a
loan company nearly $1.7 million after missing a payment in late May,
shortly after signing with the Buffalo Bills.

The ruling against Young was made in New York State
Supreme Court in Manhattan on July 2, according to court documents.

Young took out a high-risk loan from Pro Player
Funding for $1.877 million during the NFL lockout in May 2011, while he was
still under contract with the Tennessee Titans. The loan - plus $619,000 in
interest - was due to be paid back in January 2013 at an annual interest
rate of 20 percent. That rate jumped another 10 percent if Young missed a
payment.

A ruling in the lending company's favor was made
because Young agreed he understood the terms by signing what's called an
affidavit of confession of judgment upon taking out the loan. The affidavit
is regarded as proof and could be used at any time by the lender in the
event a client defaults on the loan.

TMZ.com first reported the ruling against Young
last week.

Young was unavailable for comment Thursday because
he was traveling with the Bills to Minnesota for their preseason game on
Friday. Messages left seeking comment from both the player's agent and
publicist were not returned.

Every night at
bedtime, former Celtic Ray Williams locks the doors of his home: a
broken-down 1992 Buick, rusting on a back street where he ran out of
everything.

The 10-year NBA
veteran formerly known as “Sugar Ray’’ leans back in the driver’s seat,
drapes his legs over the center console, and rests his head on a pillow of
tattered towels. He tunes his boom box to gospel music, closes his eyes, and
wonders.

Williams, a
generation removed from staying in first-class hotels with Larry Bird and
Co. in their drive to the 1985 NBA Finals, mostly wonders how much more he
can bear. He is not new to poverty, illness, homelessness. Or quiet
desperation.

In recent weeks, he
has lived on bread and water.

“They say God won’t
give you more than you can handle,’’ Williams said in his roadside sedan.
“But this is wearing me out.’’

A former top-10 NBA
draft pick who once scored 52 points in a game, Williams is a face of
big-time basketball’s underclass. As the NBA employs players whose average
annual salaries top $5 million, Williams is among scores of retired players
for whom the good life vanished not long after the final whistle.

Dozens of NBA
retirees, including Williams and his brother, Gus, a two-time All-Star, have
sought bankruptcy protection.

“Ray is like many
players who invested so much of their lives in basketball,’’ said Mike
Glenn, who played 10 years in the NBA, including three with Williams and the
New York Knicks. “When the dividends stopped coming, the problems started
escalating. It’s a cold reality.’’

Williams, 55 and
diabetic, wants the titans of today’s NBA to help take care of him and other
retirees who have plenty of time to watch games but no televisions to do so.
He needs food, shelter, cash for car repairs, and a job, and he believes the
multibillion-dollar league and its players should treat him as if he were a
teammate in distress.

One thing Williams
especially wants them to know: Unlike many troubled ex-players, he has never
fallen prey to drugs, alcohol, or gambling.

“When I played the
game, they always talked about loyalty to the team,’’ Williams said. “Well,
where’s the loyalty and compassion for ex-players who are hurting? We opened
the door for these guys whose salaries are through the roof.’’

Unfortunately for
Williams, the NBA-related organizations best suited to help him have closed
their checkbooks to him. The NBA Legends Foundation, which awarded him
grants totaling more than $10,000 in 1996 and 2004, denied his recent
request for help. So did the NBA Retired Players Association, which in the
past year gave him two grants totaling $2,000.

Continued in article

Another sports hero who does not understand personal finance.
Rule Number 1 --- Don't mess with the IRS unless you're in hiding offshore.

Italy has a public debt of nearly 2 trillion euros,
and it's cracking down on its notoriously wily tax evaders. Owners of luxury
yachts are a prime target, with tax police launching dockside raids to see
how individual tax files line up with owning and maintaining an expensive
boat.

But yachts are mobile assets. In response, many
boat owners are simply weighing anchor and setting course for more
tax-friendly Mediterranean marinas.

On-the-spot tax inspections began last winter in
Cortina d'Ampezzo, the trendy ski resort where many owners of Ferraris,
Maseratis and Lamborghinis declared incomes of less than $30,000 a year.

It's summer now, and time to hunt down yacht
owners. Tax police arrive dockside unannounced, board boats and check
owners' details against their tax files. The raids have sent shock waves
through the yachting community.

Cala Galera is a large private marina on the Tuscan
coast with close to 1,000 berths.

"Clearly and definitely we at the moment are down
with respect to other years," says marina director Pietro Capitani.

He points to the vast expanse of empty berths, and
then makes a shooting gesture to his temple.

"We are at moment almost 40 percent less than last
year. So, we are close to the [bang] for sure, for sure," he says.

A Huge Exodus

Since the tax crackdown was announced in March,
around 30,000 boats have fled Italy, seeking safer havens. They include
Slovenia, Croatia and Montenegro to the east, France and Spain to the west,
and Tunisia and Malta to the south.

The Italian association of marinas says the yacht
exodus has cost the Italian economy some $350 million this year in lost
revenues from marina fees and services, and fuel sales.

Tax authorities are unrepentant, saying it's
important to strike fear in the hears of tax dodgers. Italy has a long
history of tax evasion and it is estimated to cost the government some $160
billion a year in lost revenue.

A few miles from Cala Galera, Porto Santo Stefano
was once a favorite stop for luxury yachts cruising the clear turquoise
waters of the Tuscan marine sanctuary.

Fashion designer Valentino's yacht was once a
constant presence, as were the megaboats of Italian jet-setters. Today, it's
as empty as the Cala Galera marina.

A Blow To Local Businesses

At a waterfront sail-repair shop, Paola Valenti has
little to do.

"There are less than half the boats there were last
year," he says. "Boats used to have to drop anchor and wait off shore for a
berth to open up. This year, nothing, nothing, nothing."

One of the first boat tax raids took place in April
in the southern port of Bari. There, tax inspectors found yachts owned by
people who declared almost no income.

One of the most brazen cases was a yacht worth $1.5
million whose owner had never filed a tax return.

Despite her diminished income, Valenti has little
sympathy for tax-dodging yacht owners. "If you own a boat," she says, "you
have to have a certain declared income. You can't earn less than the sailor
who works for you."

Sen. John Kerry, who has repeatedly voted to raise
taxes while in Congress, dodged a whopping six-figure state tax bill on his
new multimillion-dollar yacht by mooring her in Newport, R.I.

Isabel - Kerry’s luxe, 76-foot New Zealand-built
Friendship sloop with an Edwardian-style, glossy varnished teak interior,
two VIP main cabins and a pilothouse fitted with a wet bar and cold wine
storage - was designed by Rhode Island boat designer Ted Fontaine.

But instead of berthing the vessel in Nantucket,
where the senator summers with the missus, Teresa Heinz, Isabel’s hailing
port is listed as “Newport” on her stern.

Could the reason be that the Ocean State repealed
its Boat Sales and Use Tax back in 1993, making the tiny state to the south
a haven - like the Cayman Islands, Bermuda and Nassau - for tax-skirting
luxury yacht owners?

Cash-strapped Massachusetts still collects a 6.25
percent sales tax and an annual excise tax on yachts. Sources say Isabel
sold for something in the neighborhood of $7 million, meaning Kerry saved
approximately $437,500 in sales tax and an annual excise tax of about
$70,000.

The senior senator’s chief of staff David Wade
denied the old salt was berthing his boat out of state to avoid ponying up
to the commonwealth.

“The boat was designed by and purchased from a
company in Rhode Island, and it’s based in Newport at the Newport Shipyard
for long-term maintenance, upkeep and charter purposes, not tax reasons,”
Wade told the Track.

And state Department of Revenue spokesguy Bob Bliss
confirmed the senator “is under no obligation to pay the commonwealth sales
tax.”

But back in 2006, then-gubernatorial candidate
Christy Mihos took some flack for avoiding some $23,000 in Bay State sales
tax and $1,320 in local excise taxes by berthing his motor yacht in Rhode
Island. But Mihos paid just $475,000 for his 36-foot vessel Ashley and
readily admitted that he used the boat at his West Yarmouth summer home.

Harvard University is investigating about 125 students
-- nearly 2 percent of all undergraduates -- who are suspected of cheating
on a take-home final during the spring semester,
The Boston Globereported Thursday. The
students will appear before the college’s disciplinary board over the coming
weeks, seem to have copied each other’s work, the dean of undergraduate
education said. Those found guilty could face up to a one-year suspension.
The dean would not comment on whether students who had already graduated
would have their degrees revoked but he did tell the Globe, “this
is something we take really, really seriously.” Harvard administrators said
they are considering new ways to educate students about cheating and
academic ethics. While the university has no honor code, the Globe
noted, its official handbook says students should “assume that collaboration
in the completion of assignments is prohibited unless explicitly permitted
by the instructor.”

Jensen Comment
The main issue is whether students plagiarized work of other students.

Ironically the course involved is "Government 1310: Introduction to
Congress." So why is does cheating in this course come as a surprise?

In years past, the course, Introduction to
Congress, had a reputation as one of the easiest at Harvard College. Some of
the 279 students who took it in the spring semester said that the teacher,
Matthew B. Platt, an assistant professor of government, told them at the
outset that he gave high grades and that neither attending his lectures nor
the discussion sessions with graduate teaching fellows was mandatory.

¶ But evaluations posted online by students after
finals — before the cheating charges were made — in Harvard’s Q Guide were
filled with seething assessments, and made clear that the class was no
longer easy. Many students, who posted anonymously, described Dr. Platt as a
great lecturer, but the guide included far more comments like “I felt that
many of the exam questions were designed to trick you rather than test your
understanding of the material,” “the exams are absolutely absurd and don’t
match the material covered in the lecture at all,” “went from being easy
last year to just being plain old confusing,” and “this was perhaps the
worst class I have ever taken.”

¶ Harvard University revealed on Wednesday that
nearly half of the undergraduates in the spring class were under
investigation for suspected cheating, for working together or for
plagiarizing on a take-home final exam. Jay Harris, the dean of
undergraduate education, called the episode “unprecedented in its scope and
magnitude.”

¶ The university would not name the class, but it
was identified by students facing cheating allegations. They were granted
anonymity because they said they feared that open criticism could influence
the outcome of their disciplinary cases.

¶ “They’re threatening people’s futures,” said a
student who graduated in May. “Having my degree revoked now would mean I
lose my job.”

¶ The students said they do not doubt that some
people in the class did things that were obviously prohibited, like working
together in writing test answers. But they said that some of the conduct now
being condemned was taken for granted in the course, on previous tests and
in previous years.

¶ Dr. Platt and his teaching assistants did not
respond to messages requesting comment that were left on Friday. In response
to calls to Mr. Harris and Michael D. Smith, the dean and chief academic
officer of the Faculty of Arts and Sciences, the university released a
statement saying that the university’s administrative board still must meet
with each accused student and that it has not reached any conclusions.

¶ “We expect to learn more about the way the course
was organized and how work was approached in class and on the take-home
final,” the statement said. “That is the type of information that the
process is designed to bring forward, and we will review all of the facts as
they arise.”

¶ The class met three times a week, and each
student in the class was assigned to one of 10 discussion sections, each of
which held weekly sessions with graduate teaching fellows. The course grade
was based entirely on four take-home tests, which students had several days
to complete and which were graded by the teaching fellows.

¶ Students complained that teaching fellows varied
widely in how tough they were in grading, how helpful they were, and which
terms and references to sources they expected to see in answers. As a
result, they said, students routinely shared notes from Dr. Pratt’s
lectures, notes from discussion sessions, and reading materials, which they
believed was allowed.

¶ “I was just someone who shared notes, and now I’m
implicated in this,” said a senior who faces a cheating allegation.
“Everyone in this class had shared notes. You’d expect similar answers.”

¶ Instructions on the final exam said, “students
may not discuss the exam with others.” Students said that consulting with
the fellows on exams was commonplace, that the fellows generally did not
turn students away, and that the fellows did not always understand the
questions, either.

¶ One student recalled going to a teaching fellow
while working on the final exam and finding a crowd of others there, asking
about a test question that hinged on an unfamiliar term. The student said
the fellow defined the term for them.

¶ An accused sophomore said that in working on
exams, “everybody went to the T.F.’s and begged for help. Some of the T.F.’s
really laid it out for you, as explicit as you need, so of course the
answers were the same.”

¶ He said that he also discussed test questions
with other students, which he acknowledged was prohibited, but he maintained
that the practice was widespread and accepted.

Jeffrey A. Michael, a finance professor in
Stockton, Calif., took a hard look at his city’s
bankruptcy this summerand thought he saw a
smoking gun: a dubious bond deal that bankers had pushed on Stockton just as
the local economy was starting to tank in the spring of 2007, he said.

Stockton sold the bonds, about $125 million worth,
to obtain cash to close a shortfall in its pension plans for current and
retired city workers. The strategy backfired, which is part of the reason
the city is now in Chapter 9 bankruptcy. Stockton is trying to walk away
from the so-called pension obligation bonds and to renegotiate other debts.

After reviewing an analysis of the bond deal,
underwritten by the ill-fated investment bank, Lehman Brothers, and watching
a recording of the Stockton City Council meeting where Lehman bankers
pitched the deal, Mr. Michael concluded that “Stockton is entitled to some
relief, due to deceptive and misleading sales practices that understated the
risk.”

“Lehman Brothers just didn’t disclose all the risks
of the transaction,” he said. “Their product didn’t work, in the same way as
if they had built a marina for the city and then the marina collapsed.”

Financial analysts and actuaries say essentially
the same pitch that swayed Stockton has been made thousands of times to
local governments all over the country — and that many of them were drawn
into deals that have since cost them dearly.

Since virtually all pension obligation bonds turn
on the same basic strategy that Stockton followed, Mr. Michael’s research
could be a road map for avoiding more such problems, or perhaps for seeking
redress. His analysis was part of his August economic forecast for the
region, which he prepares as director of the Business Forecasting Center at
the University of the Pacific.

There are about $64 billion in pension obligation
bonds outstanding, and even though issuance has slowed, more of the bonds
are coming to market, even now.

Officials in Fort Lauderdale, Fla., are scheduled
to vote on a $300 million pension obligation bond on Wednesday, for
instance. Hamden, Conn., has amended its charter to allow for the bonds to
rescue a city pension fund that is wasting away. Oakland, Calif., recently
issued about $211 million of the bonds, following the lead of several other
California cities and counties.

The basic premise of all pension obligation bonds
is that a municipality can borrow at a lower rate of interest than the rate
its pension fund assumes its assets will earn on average over the long term.
Critics contend that municipalities that try this are in essence borrowing
money and betting it on the stock market, through their pension funds. The
interest on pension obligation bonds is not tax-exempt for this reason.

Alicia H. Munnell, director of the Center for
Retirement Research at Boston College, looked at outcomes for nearly 3,000
pension obligation bonds issued from 1986 to 2009 and found that most were
in the red. “Only those bonds issued a very long time ago and those issued
during dramatic stock downturns have produced a positive return,” Ms.
Munnell wrote with colleagues Thad Calabrese, Ashby Monk and Jean-Pierre
Aubry. “All others are in the red.” Only one in five of the pension
obligation bonds issued since 1992 has matured, so the results could change
in the future.

Among the places where the strategy has failed
miserably is New Orleans, which sold about $170 million of such debt in 2000
to produce cash to finance the pensions of 820 retired firefighters. Until
then, New Orleans had never funded their benefits and simply paid them out
of pocket, leaving the retirees fearful that in a budget squeeze, the city
might renege.

City officials based the deal on the expectation
that the bond proceeds would be invested in assets that would pay 10.7
percent a year — an unusually aggressive assumption, but one that made the
numbers work. New Orleans’s credit was weak, and its borrowing rate was
expected to be 8.2 percent. To get the rate on the bonds down as much as
possible, New Orleans also issued variable-rate debt, combined with
derivatives in an attempt to hedge against rate increases.

But instead of earning 10.7 percent a year, the
bond proceeds the city set aside for the firefighters’ pensions lost value
over the years, first in the dot-com crash and then in the financial crisis.
And instead of hedging against interest rate increases, the derivatives
failed, leaving New Orleans paying 11.2 percent interest. The city also has
a $115 million balloon payment coming due on the debt in March.

Continued in article

Jensen Comment
An interesting assignment for students might be to compare the bad investment
causes of bankruptcy of Stockton, CA versus Orange County , CA,

It constantly amazes me how often the name Merrill Lynch crops up in news
accounts of both outright frauds and concerns over ethics. The latest account
is typical. A senior vic

They were an
admixture of old-fashioned and uncouth, a duo almost as unlikely as Neil Simon's
odd couple. The seventy-year-old had been married to the same woman for forty
years, in the same job for more than twenty, and in the same place--Orange
County, California--forever. The fifty-four-year-old had recently divorced and
remarried, switched jobs often and moved even more frequently, most recently to
a million-dollar home in swanky Moraga, east of Oakland, California. Despite
their obvious differences, they spoke on the phone virtually every day for many
years. They first met in 1975 and had traded billions of dollars of securities
with each other. The elder of the pair was the Orange County treasurer, Robert
Citron; the younger was a Merrill Lynch bond salesman, Mike Stamenson. Together
they created what many officials described as the biggest financial fiasco in
the United States: Orange County's $1.7 billion loss on derivative Frank Partnoy, Page 157 of Chapter 8 entitled "The Odd Couple"F.I.A.S.C.O. : The Inside Story of a Wall Street Trader
by Frank Partnoy
- 283 pages (February 1999) Penguin USA (Paper); ISBN: 0140278796
A longer passage from Chapter 8 appears at
http://www.trinity.edu/rjensen/fraud.htm#DerivativesFraud

A second passage beginning on Page 166
reads as follows:

Also
on December 5, Orange County filed the largest municipal bankruptcy petition
in history. Orange County's funds covered nearly two hundred schools,
cities, and special districts. The losses amounted to almost $1,000 for
every man, woman, and child in the county. The county's investments,
including structured notes, had dropped 27 percent in value, and the county
said it no longer could meet its obligations.

The
bankruptcy filing made the ratings agencies look like fools.
Just a few months before, in August 1994, Moody's Investors Service had
given Orange County's debt a rating of Aa1, the highest rating of any
California county. A cover memo to the rating letter stated, "Well done,
Orange County." Now, on December 7, an embarrassed Moody's declared Orange
County's bonds to be "junk"--and Moody's was regarded as the most
sophisticated ratings agency. The other major agencies, including S&P, also
had failed to anticipate the bankruptcy. Soon these agencies would face
lawsuits related to their practice of rating derivatives.

On
Tuesday, January 17, 1995, Robert Citron and Michael Stamenson delivered
prepared statements in an all-day hearing before the California Senate
Special Committee on Local Government Investments, which had subpoenaed them
to testify. It was a pitiful display. Citron left his wild clothes at
home, testifying in a dull gray suit and bifocals. He apologized and
pleaded ignorance. He said, "In retrospect, I wish I had more education and
training in complex government securities." Stuttering and subdued,
appearing to be the victim, Citron tried to excuse his whole life: He didn't
serve in the military because he had asthma; he didn't graduate from USC
because of financial troubles; he was an inexperienced investor who had
never even owned a share of stock. It was pathetic.

Stamenson also said he was sorry and cited the enormous personal pain the
calamity had produced. He pretended naivete. He said Citron was a highly
sophisticated investor and that he had "learned a lot" from him.
Stamenson's story was as absurd as Citron's was sad. When Stamenson
asserted that he had not acted as a financial adviser to the county, one
Orange County Republican, Senator William A. Craven, couldn't take it
anymore and called him a liar. Stamenson finally admitted that he had
spoken to Citron often--Citron had claimed every day--but he refused to
concede that he had been an adviser. At this point Craven exploded again,
asking, "Well, what the hell were you talking about to this man every day?
The weather?" Citron's lawyer, David W. Wiechert, was just as angry. He
said, "For Merrill Lynch to distance themselves from this crisis would be
akin to Exxon distancing themselves from the Valdez."

SUMMARY: "Oracle Corp. paid $2 million to settle Securities and
Exchange Commission accusations that an Indian subsidiary of the company
violated U.S. laws designed to prevent bribery overseas [the Foreign Corrupt
Practices Act (FCPA)]....The SEC said the ...company failed to prevent [its
subsidiary] from secretly setting aside money that eventually was used to
make unauthorized payments to vendors in India....The complaint didn't
allege Oracle bribed officials but said the funds created a risk the cash
could be used for bribery."

CLASSROOM APPLICATION: The article may be used in an auditing or
accounting systems course to cover the Foreign Corrupt Practices Act,
appropriate internal controls in support of the FCPA, and audit procedures
to detect weaknesses in internal controls and violations of the FCPA.

QUESTIONS:
1. (Advanced) What is the Foreign Corrupt Practices Act (FCPA)?
When was it established?

2. (Introductory) If the SEC "...complaint didn't allege Oracle
bribed officials," then why did Oracle pay a fine for the SEC complaint
under the FCPA?

3. (Advanced) Define the phrases "misappropriation of assets" and
"fraudulent financial reporting." Based on the description in the article,
state which of these two events occurred at Oracle's Indian subsidiary.
Support your answer.

4. (Advanced) What is a cycle approach to auditing? For the May
2006 example in the article, identify the audit cycle in which the
inappropriate transactions occurred.

5. (Advanced) For the transaction cycle described above, identify
an audit procedure that might have uncovered the inappropriate transactions.
Describe the results of the test procedure that might indicate potential
violations of internal controls and potential fraudulent transactions.

6. (Advanced) What is an approved vendor list? How does such a list
help to implement controls over the type of transaction that occurred in May
2006?

Oracle Corp. ORCL +0.77% paid $2 million to settle
Securities and Exchange Commission accusations that an Indian subsidiary of
the company violated U.S. laws designed to prevent bribery overseas.

The SEC said the business-software company failed
to prevent Oracle India Private Ltd. from secretly setting aside money that
eventually was used to make unauthorized payments to vendors in India. The
unauthorized funds, which existed from 2005 to 2007, amounted to about $2.2
million, the SEC said Thursday.

The agency said the existence of the account, which
was separate from the subsidiary's books, constituted a violation of the
Foreign Corrupt Practices Act. The complaint didn't allege Oracle bribed
officials but said the funds created a risk the cash could be used for
bribery.

Oracle in its settlement didn't admit to or deny
the allegations.

"We will continue to maintain a high standard of
compliance and accountability for our business around the world," Oracle
spokeswoman Deborah Hellinger said.

Oracle, which is based in Redwood Shores, Calif.,
discovered the funds in 2007, notified U.S. authorities and has cooperated
with the SEC investigation, the company said.

A sales manager linked to the plan resigned, the
jobs of four employees were terminated and the company has put in place
controls and training to prevent similar situations from occurring again,
Oracle said.

The settlement came amid a flurry of investigations
under the Foreign Corrupt Practices Act, a 1977 law that bars payments to
foreign officials to secure business. Pfizer Inc. PFE +1.10% this month
agreed to pay $60.2 million to settle an overseas bribery investigation that
began in 2004. Teva Pharmaceutical Industries Ltd. TEVA +0.00% disclosed
that the SEC subpoenaed documents about the company's Latin American
operations, and beauty company Avon Products Inc. AVP +0.58% said it entered
talks to end a long-running bribery investigation involving some of the
company's foreign operations.

Enforcing the act is an continuing effort, "not a
new focus," said Jina Choi, assistant regional director of the SEC in San
Francisco. The agency wants U.S. businesses to remain vigilant about
regional corruption as companies seek to increase sales world-wide, she
said.

The SEC in its seven-page complaint alleged that
Oracle India employees inflated the amounts on bills connected with eight
government contracts and then directed distributors to hold the excess cash
in so-called side funds. The complaint alleged that the employees inflated
bills approximately 14 times over two years and "made these margins large
enough to ensure a side fund existed to pay third parties," the complaint
said.

Payments from the side funds were made to
third-party businesses that "did not exist" or were "merely storefronts," it
said.

The SEC said the practice created the risk that the
funds could be used for illegal purposes, such as bribery or embezzlement.
The complaint didn't indicate whether any of the money was recovered.

Oracle didn't respond to questions about who
received the cash.

In one example, Oracle India in May 2006 secured a
$3.9 million deal with India's Ministry of Information Technology and
Communications, according to the SEC complaint. As instructed by Oracle
India's then-sales director, only $2.1 million was sent to Oracle as revenue
on the transaction. Other Oracle India employees then instructed the
distributor to park $1.7 million for "marketing development purposes," the
SEC alleged. The distributor kept $151,000 for services rendered.

Continued in article

Jensen Comment
The question is whether a $2 million settlement, like most SEC settlements these
days, is a mere chicken feed cost of doing business.

Teaching Case: Bribery by Avon in China?

From The Wall Street Journal Accounting Weekly Review on February
17, 2012

SUMMARY: "Federal prosecutors investigating whether U.S. executives
at Avon Products, Inc., broke foreign-bribery laws have presented evidence
in the probe to a grand jury...Authorities are focused on a 2005 internal
audit report by the company that concluded Avon employees in China may have
been bribing officials in violation of the Foreign Corrupt Practices Act [FCPA]...."

CLASSROOM APPLICATION: Questions ask students to consider what
audit steps they would undertake to investigate the issues identified in the
article. The article is useful in an auditing class to discuss internal
audit functions.

QUESTIONS:
1. (Introductory) Describe how Avon sells its products.

2. (Advanced) What is the Foreign Corrupt Practices Act (FCPA)? How
do the law's requirement, and general ethics, make it imperative to prevent
illegal payments or other corrupt acts?

3. (Advanced) How might Avon's business model make it difficult to
establish internal controls over items such as possible illegal payments to
foreign officials?

4. (Advanced) Define the internal audit function and compare it to
the audits done by external auditors.

5. (Introductory) How was the Avon Products, Inc. internal audit
function used in connection with the company's Chinese operations? What
evidence did the internal auditors apparently find in 2005?

6. (Advanced) Suppose you are a member of the Avon internal audit
team asked to investigate payments made out of Chinese operations. What
steps would you plan to investigate the propriety of the payments?

Federal prosecutors investigating whether
U.S. executives at Avon Products Inc. broke foreign-bribery laws have
presented evidence in the probe to a grand jury, people familiar with the
matter said.

Authorities are focused on a 2005 internal
audit report by the company that concluded Avon employees in China may have
been bribing officials in violation of the Foreign Corrupt Practices Act,
according to three people familiar with the matter. Avon had earlier said it
first learned of bribery allegations in 2008.

The audit found several hundred thousand
dollars in questionable payments to Chinese officials and third-party
consultants in 2005, one of these people said. It came as Avon was pursuing
a license to conduct door-to-door sales in China. Some of the payments were
recorded on invoices as gifts for government officials, the person said.
Avon secured China's first such license to a foreign company in 2006.

The Federal Bureau of Investigation and U.S.
prosecutors in New York and Washington are trying to determine whether
current or former executives ignored the audit's findings or actively took
steps to conceal the problems, both potential offenses, two people familiar
with the matter said.

Executives at Avon headquarters in New York
who saw the audit report at the time didn't disclose its findings to the
board's audit committee, finance committee or the full board, according to
people familiar with the investigation. Board members didn't learn of the
audit report until after Avon launched its own internal investigation of
overseas bribery allegations in 2008, say the people familiar with the
situation.

Legal experts say executives can be liable
in overseas bribery cases even if they didn't authorize illegal payments or
try to hide evidence of bribes. Under a legal concept known as willful
blindness, a person can also be found guilty of taking steps to avoid
learning of wrongdoing, they said, but prosecutors face a higher legal bar.

"We're not aware that a federal grand jury
is investigating this," said an Avon spokeswoman. She declined to confirm
whether there had been an audit in 2005 and declined to discuss how
executives handled any such audit. She said Avon is fully cooperating with
the investigation.

While grand juries gather information to
determine whether there is enough evidence to bring criminal charges, they
also can decline any action.

The investigation of Avon's headquarters
comes as members of Congress pressure the Justice Department to hold more
high-level executives accountable for corruption overseas. In December, the
government unveiled charges against a group of former executives of German
conglomerate Siemens AG. Siemens has said it is cooperating.

Avon opened an internal investigation into
possible bribery in China in 2008, more than two years after the purported
audit report. The company's internal review was later expanded to other
regions of the world. The door-to-door cosmetics company has said the
internal probe was triggered by an employee who sent a letter in 2008 to
Chief Executive Andrea Jung alleging improper spending on travel for Chinese
government officials.

The investigation put a cloud over the
12-year tenure of Ms. Jung, who won plaudits for securing the direct-sales
license in China. She said in December she would step down once the company
finds a replacement CEO; her announcement came amid pressure from investors
concerned about Avon's financial performance. Avon has said questions about
the company's activities in China kicked off probes by the Justice
Department and Securities and Exchange Commission, as well as the audit
committee of Avon's board.

Ms. Jung declined to comment. She has said
little about the investigations in the past, except that the company is
cooperating with the government.

Some high-ranking Avon executives have lost
their jobs in the probe. The company said it fired Vice Chairman Charles
Cramb on Jan. 29 in connection with the overseas corruption probe and
another investigation into allegedly improper disclosure of financial
information to analysts. Mr. Cramb couldn't be reached for comment.

Continued in article

February 17, 2012 reply from Bob Jensen to Jagdish Gangolly

Hi Jagdish,

I never suggested profiling when it comes to things like policies on
investigating and prevention of plagiarism or cheating in general. The
policies must apply to all national origins, and rule enforcement must apply
to every student and faculty member. And this is not a racial thing since
many of our Asian, Irish, Norwegian, and Latin students were born and
educated in the U.S.

What is sad, however, in the United States is when being "street smart" is
synonymous knowing how to get away with cheating relative to people who are
more trusting and are not "street smart."

I do, however, believe that there is relativism of many things in different
nations, including their heritages for bribery customs and norms for
cheating/corruption ---

Corruption Perceptions Index 2009 | Transparency International

As a footnote when viewing the graphic at the above site, I notice how
greatly some nations vary from their neighbors. For example, Argentina is
perceived as being over twice as corrupt than Chile. Italy and France are
more more corrupt than Germany even though all three nations have similar
religious (Catholic) heritages. Religion is probably not the dominant factor
in controlling corruption.

Law and tax rule enforcement, however, can be very powerful. The
least-corrupt nations seem to rise above the other nations in terms of
vigorous law enforcement and tax collections.

However, law enforcement is not synonymous with brutality. Russia, for
example, has a brutal police and prison system that has not quelled
widespread corruption. The same is true for Viet Nam.

This article was written by
Rowan Bosworth-Daviesand
first posted on his blogon March 26th 2012. It is
reused with permission. Since then, it has emerged that HSBC faces a $1
billion penalty in the United States for weak anti money laundering controls
by the US government. At a hearing in Washington this Tuesday, the US Senate
Permanent Subcommittee on Investigations is poised to deliver a blistering
attack on the London-headquartered bank’s anti-money laundering systems and
controls, highlighting its role in transactions tied to Iran, terrorist
financing and drug cartels. In aReuters
Special Reportpublished July 13th 2012, Carrick
Mollenkamp and Brett Wolf have detailed how the bank’s Delaware-based
anti-money laundering hub pays lip-service to tackling the problem of money
laundering.

Jensen Comment
A recent article in The Economist predicts that it will be really
difficult for plaintiffs in the thousands of LIBOR lawsuits to get serious
settlements. I can't recall the citation (late in August 2012), but one of the
main arguments is that use of LIBOR was volunary and not required. Also damages
are very difficult to assess since playing "what if games are very difficult
when it comes to "hypothetical impacts" of different interest rates.

Mr Echevarria, chief executive since June 2011,
defended Deloitte in an interview with Reuters - his first since the firm
was dragged into the spotlight over its independent reviews of Standard
Chartered.

The New York State Department of Financial
Services, in a case involving US anti-money laundering laws, last week said
Deloitte consultants omitted critical details in a report to regulators
about Standard Chartered.

The regulator cited an email from a Deloitte
partner saying he drafted a "watered-down version" of the report after being
asked by Standard Chartered to omit information.

"It's an unfortunate choice of words that was
pulled out of context," Mr Echevarria said.

A source close to the matter, who asked to remain
anonymous because of its sensitive nature, told Reuters that the Department
of Financial Services had no plans to bring charges against Deloitte. A
spokesman for the department refused to confirm or deny that statement.

Mr Echevarria said he was standing in line with his
16-year-old son at Universal Studios in Orlando, Florida a week ago when he
first heard of the Standard Chartered matter by email. A Bronx native in his
35th year at Deloitte, Mr Echevarria said one of his first thoughts was,
"There's got to be more to this."

The New York banking regulator head, Benjamin
Lawsky, alleged Standard Chartered hid from regulators some 60,000 "secret
transactions" tied to Iran. Standard Chartered has said the regulator's
account did not present "a full and accurate picture of the facts."

Mr Lawsky said that at one point, Standard
Chartered asked Deloitte to delete from its draft report any reference to
payments that could reveal the bank's practices involving Iranian entities.

Mr Lawsky quoted an email from a Deloitte partner
who said "we agreed" to the request.

Mr Echevarria declined to discuss specific
allegations, but in a statement last week, Deloitte said "contrary to the
allegation," it "absolutely did not delete any reference to certain types of
payments" from a final report. Deloitte said the report did not include a
recommendation that had been included in a prior draft.

"Presumably the facts will bear out that we
certainly held up all the standards required and behaved in an ethical and
responsible way," Mr Echevarria said.

Asked if Deloitte has taken action against anyone
at the firm, Mr Echevarria said he could not comment on anything involving
personnel or privacy issues.

In another damaging charge, the banking regulator
said Deloitte gave Standard Chartered two reports with highly confidential
client information - an allegation that, if true, would violate one of the
cardinal rules in the consulting business.

"We have pretty robust processes in place for
behaviour that violates law, rules or firm policies," Mr Echevarria said.
"Appropriate actions are taken when individuals are found to have done
that."

Mr Echevarria, who rose through the auditing ranks
to become chief executive, has battled a series of reputational hits since
taking over the US firm.

Late last year, the firm came under scrutiny from a
member of Congress after audit industry regulators unsealed parts of a
report criticizing quality controls at Deloitte's corporate auditing
business. Deloitte said at the time that it had made investments to improve
its audit practice.

Continued in article

As Andersen discovered, one felony conviction in the U.S. can end a firm's
auditing practice in the entire U.S. I cannot imagine any large auditing firm
gambling with its nationwide authority to conduct audits. However, doubt
that this risk applies to certain rogue author or consultant convictions such as
when a single partner is convicted on insider trading that was much of a
surprise to the firm as it was the SEC and the public. There's a huge gray zone,
especially for a firm like Deloitte that did not sell or spin off most of its
consulting practice before SOX went into effect. The auditing firms that are
roaring back into consulting are putting their auditing divisions somewhat at
risk.

In this article I propose a theory of Spain's
political class to make a case for the urgent, imperious need to change our
voting system and adopt a majority system. A good theory of Spain's
political class should at least explain the following issues:

1. How is it possible that five years after the
crisis began, no political party has a coherent diagnosis of what is going
on in Spain?

2. How is it possible that no political party has a
credible long-term plan or strategy to pull Spain out of the crisis? How is
it possible that Spain's political class seems genetically incapable of
planning?

3. How is it possible that Spain's political class
is incapable of setting an example? How is it possible that nobody - except
the king and for personal motives at that - has ever apologized for
anything?

4. How is it possible the most obvious strategy for
a better future - improving education, encouraging innovation, development
and entrepreneurship, and supporting research - is not just being ignored,
but downright massacred with spending cuts by the majority parties?

In the following lines I posit that over the last
few decades, Spain's political class has developed its own particular
interest above the general interest of the nation, which it sustains through
a system of rent-seeking. In this sense it is an extractive elite, to use
the term popularized by Acemoglu and Robinson. Spanish politicians are the
main culprits of the real estate bubble, of the savings banks collapse, of
the renewable energy bubble and of the unnecessary infrastructure bubble.
These processes have put Spain in the position of requiring European
bailouts, a move which our political class has resisted to the bitter end
because it forces them to implement reforms that erode their own particular
sphere of interest. A legal reform that enforced a majority voting system
would make elected officials accountable to their voters instead of to their
party leaders; it would mark a very positive turn for Spanish democracy and
it would make the structural reforms easier. THE HISTORY

The politicians who participated in the transition
process from Franco's regime to democracy came from very diverse
backgrounds: some had worked for Franco, others had been in exile and yet
others were part of the illegal opposition within national borders. They had
neither a collective spirit nor a particular group interest. These
individuals made two major decisions that shaped the political class that
followed them. The first was to adopt a proportional representation voting
system with closed, blocked lists. The goal was to consolidate the party
system by strengthening the internal power of their leaders, which sounded
reasonable in a fledgling democracy. The second decision was to strongly
decentralize the state with many devolved powers for regional governments.
The evident dangers of excessive decentralization were to be conjured by the
cohesive role of the great national parties and their strong leaderships. It
seemed like a sensible plan.

But four imponderables resulted in the young
Spanish democracy acquiring a professional political class that quickly grew
dysfunctional and monstrous. The first was the proportional system with its
closed lists. For a long time now, members of party youth groups get
themselves on the voting lists on the sole merit of loyalty to their
leaders. This system has turned parties into closed rooms full of people
where nobody dares open the windows despite the stifling atmosphere. The air
does not flow, ideas do not flow, and almost nobody in the room has personal
direct knowledge of civil society or the real economy. Politics has become a
way of life that alternates official positions with arbitrarily awarded jobs
at corporations, foundations and public agencies, as well as sinecures at
private regulated companies that depend on the government to prosper.

Secondly, the decentralization of the state, which
began in the early 1980s, went much further than was imaginable when the
Constitution was approved. As Enric Juliana notes in his recent book Modesta
España (or, Modest Spain), the controlled top-down decentralization was
quicky overtaken by a bottom-up movement led by local elites to the cry of
"We want no less!" As a result, there emerged 17 regional governments, 17
regional parliaments and literally thousands of new regional companies and
agencies whose ultimate goal in many cases was simply to extend paychecks
and bonuses. In the absence of established procedures for selecting staff,
politicians simply appointed friends and relatives, which led to a
politicized patronage system. The new political class had created a
rent-seeking system - that is to say, a system that does not create new
wealth but appropriates existing wealth - whose sewers were a channel for
party financing.

Thirdly, political parties' internal power was
decentralized even faster than the public administration. The notion that
the Spain of the Regions could be managed by the two majority parties (the
conservative Popular Party and the Socialists) fell apart when the regional
"barons" accumulated power and, like the Earl of Warwick, became kingmakers
within their own parties. This accelerated the decentralization and loss of
control over the regional savings banks. Regional governments quickly passed
laws to take over the cajas de ahorros, then filled the boards with
politicians, unionists, friends and cronies. Under their leadership, the
savings banks financed or created yet more businesses, agencies and
affiliated foundations with no clear goal other than to provide yet more
jobs for people with the right connections.

Additionally, Spain's political class has colonized
areas that are not the preserve of politics, such as the Constitutional
Court, the General Council of the Judiciary (the legal watchdog), the Bank
of Spain and the CNMV (the market watchdog). Their politicized nature has
strangled their independence and deeply delegitimized them, severely
deteriorating our political system. But there's more. While it invaded new
terrain, the Spanish political class abandoned its natural environment:
parliament. Congress is not just the place where laws are made; it is also
the institution that must demand accountability. This essential role
completely disappeared in Spain many years ago. The downfall of Bankia,
played out grotesquely in last July's parliamentary appearances, is just the
latest in a long series of cases that Congress has decided to treat as
though they were natural disasters, like an earthquake, which has victims
but no culprits. THE BUBBLES

These processes created a political system in which
institutions are excessively politicized and where nobody feels responsible
for their actions because nobody is held accountable. Nobody within the
system questions the rent-seeking that conforms the particular interest of
Spain's political class. This is the background for the real estate bubble
and the failure of most savings banks, as well as other "natural disasters"
and "acts of God" that our politicians are so good at creating. And they do
so not so much out of ignorance or incompetence but because all these acts
generate rent.

The Spanish real estate bubble was, in relative
terms, the largest of the three that are at the origin of today's global
crisis, the US bubble and the Irish bubble being the other two. There is no
doubt that, like the others, it fed on low interest rates and macroeconomic
imbalances on a global scale. But unlike the US, in Spain decisions
regarding what gets built where are taken at the political level. In Spain,
the political class inflated the real estate bubble through direct action,
not omission or oversight. City planning is born out of complex, opaque
negotiations which, besides creating new buildings, also give rise to party
financing and many personal fortunes, both among the owners of rezoned land
and those doing the rezoning. As if this power were not enough, by
transferring control of the savings banks to regional governments the
politicians also had power of decision over who received money to build.
This represented a quantum leap in the Spanish political class' capacity for
rent-seeking. Five years on, the situation could not be more bleak. The
Spanish economy will not grow for many years to come. The savings banks have
disappeared, mostly due to bankruptcy.

The other two bubbles I will mention are a result
of the peculiar symbiosis between our political class and Spanish
capitalists who live off government favors. At a recent meeting, a
well-known foreign investor called it "an incestuous relationship" while a
Spanish investor talked about "a collusion against consumers and taxpayers."
Be that as it may, let us first discuss the renewable energy bubble. Spain
represents two percent of world GDP yet it is paying 15 percent of the
global total of renewable energy subsidies. This absurd situation, which was
sold to the public as a move that would put Spain on the forefront of the
fight against climate change, creates lots of fraud and corruption, and
naturally captured rent, too. In order to finance these subsidies, Spanish
households and businesses pay the highest electricity rates in all of
Europe, which seriously undermines the competitiveness of our economy.
Despite these exaggerated prices, the Spanish power system debt is several
million euros a year, with an accumulated debt of over 24 billion euros that
nobody knows how to pay.

The last bubble I will discuss concerns the
countless unnecessary infrastructure projects built in the last two decades
at an astronomical cost, benefiting the builders and hurting the taxpayers.
One of the most scandalous cases is the spoke highways into and out of
Madrid. Meant to improve traffic flows into the capital, the radiales were
built with no thought given to important principles of prudence and good
management. First, rash forecasts were made regarding the potential traffic
on these roads (currently it is 30 percent of expectations and not because
of the crisis; there was no traffic in boom times, either.) The government
allowed the builders and the concessionaires to be essentially the same
people. This is madness, because when builders disguised themselves as
license holders through companies with very little capital and huge debt,
builders basically got money from the concessionaires to build the highways,
and when there was no traffic, they threatened to let the latter go broke.
The main creditors were - surprise! - the savings banks. So nobody knows how
to pay the more than three billion euros in debt, which will ultimately fall
on the taxpayers' shoulders. THE THEORY

The principle is very simple. Spain's political
class has not only turned itself into a special interest group, like air
traffic controllers for example; it has taken a step further and formed an
extractive elite in the sense given to this term by Acemoglu and Robinson in
their recent and already famous book Why Nations Fail. An extractive elite
is defined by:

"Having a rent-seeking system which allows, without
creating new wealth, for the extraction of rent from a majority of the
population for one's own benefit."

"Having enough power to prevent an inclusive
institutional system - in other words, a system that distributes political
and economic power broadly, that respects the rule of law and free market
rules."

Abominating the 'creative destruction' that
characterizes the most dynamic forms of capitalism. In Schumpeter's words,
"creative destruction is the process of industrial mutation that incessantly
revolutionizes the economic structure from within, incessantly destroying
the old one, incessantly creating a new one." Innovation tends to create new
centers of power, and that's why it is detested.

What does this simple theory have to say about the
four questions set forth at the beginning of this article? Let us see:

1. Spain's political class, as an extractive elite,
cannot effect a reasonable diagnosis of the crisis. It was their
rent-seeking mechanisms that provoked it, but obviously they cannot say
that. The Spanish political class needs to defend, as it is indeed doing to
a man, that the crisis is an act of God, something that comes from the
outside, unpredictable by nature, and in the face of which we can only show
resignation.

2. Spain's political class, as an extractive elite,
cannot have any exit strategy other than waiting for the storm to pass. Any
credible long-term plan must include the dismantling of the rent-seeking
mechanisms that the political class benefits from. And this is not an
option.

4. Just as the theory of extractive elites states,
Spanish political parties share a great contempt for education, innovation
and entrepreneurship, and a deep-seated hostility towards science and
research. The loud arguments over the civics education course Educación para
la Ciudadanía are in stark contrast with the thick silence regarding the
truly relevant problems of our education system. Meanwhile, innovation and
entrepreneurship languish in the midst of regulatory deterrents and punitive
fiscal measures. And spending on scientific research is viewed as a luxury
that politicians cut back savagely on, given half a chance.

The attacks, which began in late 2011 and escalated
this year, have primarily been "denial of service" campaigns that disrupted
the banks' websites and corporate networks by overwhelming them with
incoming web traffic, said the sources.

Whether the hackers have been able to inflict more
serious damage on computer networks or steal critical data is not yet known.
The sources said there was evidence suggesting the hackers targeted the
banks in retaliation for their enforcement of Western economic sanctions
against Iran.

Iran has beefed up its cyber capabilities after its
nuclear program was damaged in 2010 by the Stuxnet virus, widely believed to
have been developed by the United States. Tehran has publicly advertised its
intentions to build a cyber army and encouraged private citizens to hack
against Western countries.

The attacks on the three largest U.S. banks
originated in Iran, but it is not clear if they were launched by the state,
groups working on behalf of the government, or "patriotic" citizens,
according to the sources, who requested anonymity as they were not
authorized to discuss the matter.

They said the attacks shed new light on the
potential for Iran to lash out at Western nations' information networks.

"Most people didn't take Iran seriously. Now most
people are taking them very seriously," said one of the sources, referring
to Iran's cyber capabilities.

Iranian officials were not available for comment.
Bank of America, JPMorgan and Citigroup declined to comment, as did
officials with the Pentagon, U.S. Department of Homeland Security, Federal
Bureau of Investigation, National Security Agency and Secret Service.

A U.S. financial services industry group this week
warned banks, brokerages and insurers to be on heightened alert for cyber
attacks after the websites of Bank of America and JPMorgan Chase's
experienced unexplained service disruptions.

NBC reported late on Thursday that the Iranian
government was behind these attacks, citing U.S. national security sources.
Reuters could not verify that independently.

Tensions between the United States and Iran, which
date back to the revolution in 1979 that resulted in the current Islamic
republic, have escalated in recent years as Washington led the effort to
prevent Tehran from getting a nuclear bomb and imposed tough economic
sanctions.

DISRUPTIVE CAMPAIGN

Denial-of-service campaigns are among the oldest
types of cyber attacks and do not require highly skilled computer
programmers or advanced expertise, compared with sophisticated and
destructive weapons like Stuxnet.

But denial-of-service attacks can still be very
disruptive: If a bank's website is repeatedly shut down, the attacks can
hurt its reputation, affect customer retention and cause revenue losses as
customers cannot open accounts or conduct other business.

Bank of America, Citigroup and JPMorgan Chase have
consulted the FBI, Department of Homeland Security and National Security
Agency on how to strengthen their networks in the face of the Iranian
attacks, the sources said. It was not clear whether law enforcement agencies
are formally investigating the attacks.

The Iranian attackers may have used
denial-of-service to distract the victims from other, more destructive
assaults that have yet to be uncovered, the sources said.

Frank Cilluffo, who served as homeland security
adviser to U.S. President George W. Bush, told Reuters that he knows of
"cyber reconnaissance" missions that have come from Iran but declined to
give specifics.

"It is yet to be seen whether they have the
wherewithal to cause significant damage," said Cilluffo, who is now director
of the Homeland Security Policy Institute at George Washington University.

Continued in article

Jensen Comment
Cyberwars work both ways. President Obama bragged that U.S. succeeded in burning
out millions of dollars worth of Iranian centrifuges.

It has been said that the only survivors of a
nuclear holocaust will be cockroaches and Cher. At this point, it might seem
reasonable to add E. Gordon Gee to that list.

At a time when college leaders are being tossed out
at the very first whiff of a scandal, the Ohio State University president
appears impervious to controversy.

Over the course of his decades-long career in
higher education, Mr. Gee has weathered athletics scandal, spending probes,
and even jokes about his ex-wife's smoking pot in the president's residence
at Vanderbilt University.

Through it all, the unflappable Mr. Gee, 68, has
never seemed to stop smiling.

Answer
Many of their returns on investments in things like pension funds were
diminished by U.K. bank conspiracies to manipulate LIBOR. And millions of
interest rate swaps based upon LIBOR underlyings (notionals in the trillions)
did not have fair and just settlements. What a huge mess going on while PwC and
other Big Four auditing firms slept!!!

Rate-fixing scandal

In June 2012, as a result of an international investigation, Barclays
Bank was fined a total of £290 million (US$450 million) for attempting to
manipulate the daily settings of London Interbank Offered Rate (Libor)
and the Euro Interbank Offered Rate (Euribor).
The United States Department of Justice and Barclays officially agreed that
"the manipulation of the submissions affected the fixed rates on some
occasions".[94]
The bank was found to have made 'inappropriate submissions' of rates which
formed part of the Libor and Euribor setting processes, sometimes to make a
profit, and other times to make the bank look more secure during the
financial crisis.[95]
This happened between 2005 and 2009, as often as daily.[96]

The
BBC said
revelations concerning the fraud were "greeted with almost universal
astonishment in the banking industry."[97]
The UK's
Financial Services Authority (FSA), which levied a fine of £59.5 million
($92.7 million), gave Barclays the biggest fine it had ever imposed in its
history.[96]
The FSA's director of enforcement described Barclays' behaviour as
"completely unacceptable", adding "Libor is an incredibly important
benchmark reference rate, and it is relied on for many, many hundreds of
thousands of contracts all over the world."[95]
The bank's chief executive
Bob Diamond decided to give up his bonus as a result of the fine.[98]
Liberal Democrat politician
Lord Oakeshott criticised Diamond, saying: "If he had any shame he would
go. If the Barclays board has any backbone, they'll sack him."[95]
The U.S. Department of Justice has also been involved, with "other financial
institutions and individuals" under investigation.[95]
On 2 July 2012, Marcus Agius resigned from the chairman position following
the interest rate rigging scandal.[99]
On 3 July 2012, Bob Diamond resigned with immediate effect, leaving Marcus
Agius to fill his post until a replacement is found.[100]

Ever wonder why surveys about very personal topics
(think sex and money) are done anonymously? Of course you don't, because
it's obvious that people wouldn't tell the truth if they were identified on
the record. That's a key point in understanding the latest scandal to hit
the banking industry, which comes, as ever, with much hand-wringing,
assorted apologies and a crazy-sounding acronym--this time, LIBOR. That's
short for the London interbank offered rate, the interest rate that banks
charge one another to borrow money. On June 27, Britain's Barclays bank
admitted that it had deliberately understated that rate for years.

LIBOR is a measure of banks' trust in their
solvency. And around the time of the financial crisis of 2008, Barclays'
rate was rising. If a bank revealed publicly that it could borrow only at
elevated rates, it would essentially be admitting that it--and perhaps the
financial system as a whole--was vulnerable. So Barclays gamed the system to
make the financial picture prettier than it was. The charade was possible
because LIBOR is calculated not on the basis of documented lending
transactions but on the banks' own estimates, which can be whatever bankers
decree. This Kafkaesque system is overseen for bizarre historical reasons by
an association of British bankers rather than any government body.

The LIBOR scandal has already claimed Barclays'
brash American CEO, Bob Diamond, a man infamous for taking huge bonuses
while his company's share price and profit were declining. Diamond resigned,
but his head may not be the only one to roll. As many as 20 of the world's
largest banks are being sued or investigated for manipulating over the
course of many years the interest rate to which $350 trillion worth of
derivatives contracts are pegged. Bank of England and former
British-government officials accused of colluding with Barclays to stem a
financial panic may also be caught up in the mess.

What's surprising is that individual consumers may
actually have benefited, at least financially, from the collusion. Not only
the central reference point for derivatives markets, LIBOR is also the rate
to which all sorts of loans--variable mortgage rates, student loans, even
car payments--may be pegged. To the extent that banks kept LIBOR
artificially low, all those other loan rates were marked down too. Unlike
the JPMorgan trading fiasco of a few weeks ago, which has resulted in a
multibillion-dollar loss, the only apparent red ink so far in the LIBOR
scandal is the $450 million in fines that Barclays will pay to the U.K. and
U.S. governments for rigging rates (though pension funds and insurance
companies on the short end of LIBOR-pegged financial transactions may have
lost a lot of money).

Either way, the truth is that LIBOR is a much, much
bigger deal than what happened at JPMorgan. Rather than one screwed-up trade
that was--whether you like it or not (and I don't)--most likely legal, it
represents a financial system that is still, four years after the crisis
began, opaque, insular and dangerously underregulated. "This is a very, very
significant event," says Gary Gensler, chairman of the U.S. Commodity
Futures Trading Commission (CFTC), which is one of the regulators
investigating the scandal. "LIBOR is the mother of all financial indices,
and it's at the heart of the consumer-lending markets. There have been
winners and losers on both sides [of the LIBOR deals], but collectively we
all lose if the market isn't perceived to be honest."

Are companies in denial when it comes to
executives' annual bonuses for 2011? Judge for yourself.

Among 265 companies that participated in a
newly released Towers Watson survey, 42% said their shareholders'
total returns were lower this year than in 2010. No surprise there,
given the stock markets' flat performance in 2011.

Yet among those that reported declining
shareholder value, a majority (54%) said they expected their bonus
plan to be at least 100% funded, based on the plan's funding
formula. That wasn't much behind the 58% of all companies that
expected full or greater funding (see chart).

"It boggles the mind. How do you articulate
that to your investors?" asks Eric Larre, consulting director and
senior executive pay consultant at Towers Watson. Noting that stocks
performed excellently in 2010 while corporate earnings stagnated —
the opposite of what has happened this year — he adds, "How are you
going to say to them, 'We made more money than we did last year, but
you didn't'?"

In particular, companies would have to
convincingly explain that annual bonus plans are intended to
motivate executives to achieve targets for short-term, internal
financial metrics such as EBITDA, operating margin, or earnings per
share, and that long-term incentive programs — which generally rest
on stock-option or restricted-stock awards, giving executives, like
investors, an ownership stake in the company — are more germane to
investors.

But such arguments may hold little sway
with the average investor, who "doesn't bifurcate compensation that
discretely," says Larre. Rather, investors simply look at the pay
packages as displayed in the proxy statement to see how much top
executives were paid overall, and at how the stock performed.

Larre attributes much of the current,
seeming generosity to executives to complacence within corporate
boards. This year, the first in which public companies were required
to give shareholders an advisory ("say on pay") vote on
executive-compensation plans, 89% received a thumbs-up. But that
came on the heels of 2010, when the S&P 500 gained some 13% and
investors were relatively content with their returns. "They may not
be as content now," Larre observes. "I think the number of 'no'
say-on-pay votes will be larger during the 2012 proxy season."

Sandy Weill was impressive as a scrambler, a
dealmaker, a man who could catch a wave. He's come out of retirement now, a
decade after creating the Citigroup oligopolist, to catch a new wave,
declaring on CNBC that investment banking and commercial banking should be
re-separated.

He explains that bank bailouts and too big to fail
would no longer be necessary, without explaining how, since both bank
bailouts and too big to fail predated the repeal of Glass-Steagall.

Mr. Weill finds himself suddenly welcome in the
company of editorialists who, since the Libor scandal, have been renewing
their clamor for bankers to be imprisoned, if not executed. He's become
their new hero.

The inherent Stalinism of those who crave to put
bankers in jail for things that aren't crimes is not unlike that of the
original Stalinist—who understood that nothing of substance has to change if
you've got enough scapegoats. Likewise, Mr. Weill's proposal to restore
Glass-Steagall would also change nothing.

Even too big to fail is too small a phrase. Do not
interpret the following conspiratorially: The total coalescence of the
financial elite with the governing elite in our and other countries is a
natural pattern. It may be corrupting. It may be counterproductive. But it's
the natural outcome of the giant, almost inconceivable amounts of debt the
U.S. and other governments ask the financial system to market and hold on
their behalf.

If you owe the bank $1 million, the bank owns you.
If you owe $1 billion, you own the bank. If you owe several trillion, you
are the financial system. Libor is called a key underpinning of global
finance. But that's far more true of IOUs issued by the U.S. government and
its major counterparts. The global financial system is built on a mountain
of government debt, and in turn banks and their governments are bedfellows
of a highly incestuous order.

That's why, in every transcript and phone
memorandum that has come to light, in talking about Libor, regulators and
bankers talk to each other as if they were all just bankers talking amongst
themselves.

That's why, when a high British official suggested
that Barclays lowball its Libor submission during the financial crisis,
Barclays didn't hesitate because, as one banker testified to the British
Parliament, these were government instructions "at a time when governments
were tangibly calling the shots."

It's ironic to think that some who championed the
euro saw it as way to break free of rule by bankers. Europe's new monetary
authority would be focused on a producing a stable currency; Europe's
national governments would have no choice but to live within their means.

This experiment failed because the European Central
Bank quickly adopted policies designed to induce banks not to distinguish
between the debts of disciplined and undisciplined governments. That is, the
euro was immediately corrupted by the need to help governments keep
financing themselves.

Now the world is Europe. Under the current regime
of financial repression, banks and states are even more annexes of each
other. Notice Japan's central bank explicitly stating plans to erode the
value of the government's debt in the hands of Japanese savers. Notice the
European Central Bank again hinting at readiness to buy the debt of
countries no longer able to find voluntary buyers in the market. In the
U.S., how long before the Treasury issues a perpetual bond yielding zero
percent for direct sale to the Fed?

The banker-government consortium re-exposed in the
Libor scandal won't be unwound from the top, not when governments are more
dependent than ever on a captive financial system to give their debt the
illusion of viability. And yet there's still a possibility of unwinding it
from the bottom, by giving large numbers of bankers an incentive to get out
of the government-insured sector and go back to a world in which they live
by their own profits and losses.

The solution begins with deposit-insurance reform.
The FDIC would stop insuring deposits that are invested in anything other
than U.S. Treasury paper. The FDIC would be charged solely with seizing
these assets when a bank gets in trouble so the claims of insured depositors
can be satisfied. There'd be no call to bail out other creditors or
shareholders to minimize the cost to the deposit insurance fund.

Yes, the threat might be only semi-credible. But
such a law could be got through Congress and risk-averse lenders would
become less interested in holding uninsured credit against banks that are
too big to manage and too opaque to be viable without a government backstop.

SUMMARY: "Credit Suisse is handing over more internal documents to
U.S. authorities in response to Washington's crackdown on tax
evasion....Earlier this year, Switzerland's second-largest bank by assets
and at least four smaller lenders transferred correspondence concerning
details of their U.S. operations and containing thousands of names of
employees who have dealt with American clients, causing controversy in
Switzerland over personal privacy."

CLASSROOM APPLICATION: The article may be used to discuss
on-the-job ethical decision making.

QUESTIONS:
1. (Introductory) How have American taxpayers evaded taxes using
Swiss bank accounts, particularly UBS? You may refer to the related article
to help answer this question.

2. (Advanced) What is a tax amnesty program?

3. (Introductory) How can information from the bank Credit Suisse,
which excludes client data, help U.S. authorities to uncover tax evasion by
American taxpayers?

4. (Introductory) What is the concern at Credit Suisse about
employee names being included in the correspondence that is to be delivered
to the U.S. government?

5. (Advanced) Suppose you are a Swiss employee of a bank who is
asked to handle a foreign citizen's account activities. Suppose you suspect
that the account holder is evading home country taxation and you think that
your employer condones this behavior. What actions would you consider
taking? What personal risks are associated with the actions?

Credit Suisse . . . is handing over more
internal documents to U.S. authorities in response to Washington's crackdown
on tax evasion, according to an internal memo reviewed by The Wall Street
Journal.

Earlier this year, Switzerland's second-largest
bank by assets and at least four smaller lenders transferred correspondence
concerning details of their U.S. operations and containing thousands of
names of employees who have dealt with American clients, causing controversy
in Switzerland over personal privacy.

Credit Suisse has since held talks with
Switzerland's data-privacy watchdog and agreed that it will give staff the
option of obtaining information about transfers of data in advance.

A spokesman for Credit Suisse confirmed the memo's
contents. All client-specific data have been removed from the business
records that will be transferred, as they were from the first batch of
records. The employees whose names are in the data aren't suspected of
having helped Americans avoid taxes.

Switzerland has come under enormous pressure to
stop allowing foreigners to use its bank-secrecy laws to evade taxes after
UBS AG, UBS -1.02% the nation's biggest lender by assets, in 2009 admitted
wrongdoing in helping Americans hide money from tax authorities. UBS agreed
to turn over the names of more than 4,500 U.S. account holders and paid a
$780 million fine. Thousands of Americans, not all of whom had accounts with
UBS, have since voluntarily disclosed their accounts under two U.S. tax
amnesties.

Information gathered from the UBS accounts and
voluntary disclosures allowed U.S. authorities to identify 11 more banks,
including Credit Suisse, that U.S. authorities say may have helped Americans
evade taxes, leading to an expansion of the investigations starting last
year.

Eager to end the pressure from Washington, the
Swiss government has been negotiating a sweeping settlement that would
govern transfers of data from all Swiss banks and ensure that all U.S.
assets held in the country are taxed. Switzerland also hopes that the
agreement would allow U.S. residents to keep private accounts held in the
country, as long as taxes due on those assets are paid.

Little progress has been made in concluding the
talks.

In July 2011, the U.S. Department of Justice
notified Credit Suisse that it was a formal target of a criminal
investigation into how Swiss financial institutions allegedly helped U.S.
citizens avoid paying U.S. income tax. In April, the Swiss government gave
banks permission to send the Justice Department the information it sought,
within the limits of Swiss law.

"The documents concerned comprise e-mail
correspondence, including attachments, with clients domiciled in the U.S.,
as well as internal e-mail correspondence, including attachments, about
clients domiciled in the U.S. and the U.S. cross-border business in general
during the period from June 2001 to March 2011," Hans-Ulrich Meister, who
heads Credit Suisse's private-banking unit, told staff in the memo.

The latest records earmarked for transfer to the
U.S. include names of employees of Credit Suisse's private-banking division
who served clients in relation to business with the U.S. The memo invites
staff members who aren't sure whether their names will be included in the
coming transfer to contact a help desk for more information.

"The latest scam designed to separate Missouri
residents from their money involves phony letters from the State Attorney
General's office, the IRS and other government agencies," St. Louis Public
Radio reports.

Attorney General Chris Koster explains how the
fraud works: "I have in my hand a letter from 'the FBI.' [It] claims that,
'you have won $3.5 million, but you owe $2,600 in a winner's fee, and you
need to submit it' to this address, which so far we have traced to Florida."

We know how that is. Not long ago we received a
similar letter. It purported to be from the Social Security Administration.
The gist of it was that the government was promising to pay for our
retirement, but only if we cough up more money now: "Without changes, by
2037 the Social Security Trust Fund will be exhausted and there will be
enough money to pay only about 76 cents for each dollar of scheduled
benefits. We need to resolve these issues soon."

The letter bore the signature "Michael J. Astrue,
Commissioner." We laughed and put it aside, digging it out of our files when
we read about the similar letters from Missouri. We've now traced it to an
address near Washington, D.C. In an unlikely twist,
Michael Astrueactually is the
commissioner of the Social Security Administration. Even so, we're glad we
didn't send any money.

The federal government has been making such
too-good-to-be-true offers for decades--the "Social Security" game dates all
the way back to 1935--but such scams seem to be multiplying of late. An
example appears on the
White Housewebsite under the heading "Did You Get
a Check?"

The beneficiaries of the subsidies have changed as
agriculture in the United States has changed. In the 1930s, about 25% of the
country's population resided on the nation's 6,000,000 small farms. By 1997,
157,000 large farms accounted for 72% of farm sales, with only 2% of the
U.S. population residing on farms. In 2006, the top 3 states receiving
subsidies were Texas (10.4%), Iowa (9.0%), and Illinois (7.6%). The Total
USDA Subsidies from farms in Iowa totaled $1,212,000,000 in 2006.[12] From
2003 to 2005 the top 1% of beneficiaries received 17% of subsidy
payments.[12] In Texas, 72% of farms do not receive government subsidies. Of
the close to $1.4 Billion in subsidy payments to farms in Texas, roughly 18%
of the farms receive a portion of the payments.

Jensen Comment
The biggest example of Farm Lobby absurdity of requiring that 10% of every
gallon of gasoline be U.S. produced corn ethanol. Corn ethanol takes more energy
to produce (mostly in consumption of natural gas) than it yields, unlike
Brazil's more energy-rish sugar cane ethanol. Furthermore corn ethanol does not
ship well through pipelines and has to be trucked to refineries. And most
importantly in drought times like these the demand for corn at ethanol producing
plants drives up the price of corn even further, making it harder for farmers
and ranchers and food manufacturing plants (like those that produce cereals and
corn syrup) to feed livestock and people.
http://en.wikipedia.org/wiki/Ethanol_fuel

Senator Tom Harkin (D Iowa) recently wrote a blistering report aimed at
for-profit university frauds. At the same time he's a prime mover of the corn
ethanol fraud since he's in the pockets of agribusiness and agribusiness labor
unions ---
http://en.wikipedia.org/wiki/Tom_Harkin

As a matter of fact I'm suspicious that his blistering report about
for-profit colleges was probably ghost written by teachers unions since Tom is
also in the pockets of teachers unions.

A U.S. Senate committee released an unflattering
reporton the for-profit college sector on Sunday,
concluding a two-year investigation led by Sen. Tom Harkin, an Iowa
Democrat. While the report is ambitious in scope, and scathingly critical on
many points, it appears unlikely to lead to a substantial legislative
crackdown on the industry -- at least not during this election year.

Issued by staff from the Democratic majority of the U.S. Senate Committee on
Health, Education, Labor and Pensions, the report follows six congressional
hearings, three previous reports and broad document requests. The
final result is voluminous, weighing in at 249
pages and accompanied by in-depth profiles of 30 for-profits. It questions
whether federal investment through aid and loans is worthwhile in many of
the examined colleges.

The investigation found that large numbers of students at for-profits fail
to earn credentials, citing a 64 percent dropout rate in associate degree
programs, for example. It also links those high dropout rates to the
relatively small amount of money for-profits spend on instruction.

For-profits “devote tremendous amounts of resources to non-education related
spending,” the report said, with the sector spending more revenue on both
marketing and profit-sharing than on instruction. In 2009, the examined
companies spent $4.1 billion or 22.4 percent of all revenue on marketing,
advertising, recruiting and admissions staffing. Profit distributions
accounted for $3.6 billion or 19.4 percent of revenue. In contrast, the
companies spent $3.2 billion or 17.7 percent on instruction, according to
the report.

The industry's trade group, the Association of Private Sector Colleges and
Universities,
fired back with a rebuttal, saying the report
"twists the facts to fit a narrative, proving that this is nothing more than
continued political attacks." For example, the association said the sector's
overall graduation rate at two-year colleges is a much higher 62 percent.

Republican staff members also contributed a dissent
to the report, saying it is “indisputable that significant problems exist”
at some for-profits, but that the investigation was not conducted in a
bipartisan manner. They also raised doubts about the report’s accuracy,
noting, for example, that the committee relied in part on testimony from the
Government Accountability Office,
some of which was flawedand has been revised.

The final report does include a bit of praise for the industry, noting that
it is here to stay, and will continue to play a significant role in serving
growing numbers of nontraditional and disadvantaged groups of students,
including adults.

Please note that I'm not a huge advocate of for-profit universities, and I've
written a great deal about those universities operating in the gray zone of
fraud. However, few readers of Senator Tom Harkins report will realize that this
is really a teachers union report. Such is the devious union mouthpiece named
Tom Harkin.

European banks resorted to a number of misleading ploys to avoid taking fair
value adjustment hits to prevent earnings hits due to required fair value
adjustments of investments that crashed such a investments in the bonds of
Greece, Ireland, Spain, and Portugal.

The Market Transitory Movements Argument
Fair value adjustments can be avoided if they are viewed as temporary transitory
market fluctuations expected to recover rather quickly. This argument was used
inappropriately by European banks hold billions in the Greece, Ireland,
Spain, and Portugal after the price declines could hardly be viewed as
transitory. The head of the IASB at the time, David Tweedie, strongly objected
to the failure to write down financial instruments to fair value. The banks, in
turn, threatened to pressure the EU lawmakers to override the IFRS 9 requirement
to adjust such value declines to market.

One of the major concerns of the is that some nations at some points in
time will simply not enforce the IASB standards that these nations adopted. The
biggest problem that the IASB was having with European Banks is that the IASB
felt many of many (actually most) EU banks were not conforming to standards for
marking financial instruments to market (fair value). But the IASB was really
helpless in appealing to IFRS enforcement in this regard.

When the realities of European bank political powers, the IASB quickly caved
in as follows with a ploy that allowed European banks to lie about intent to
hold to maturity. The banks would probably love to unload those loser bonds as
quickly as possible before default, but they could instead claim that these
investments were intended to be held to maturity --- a game of make pretend that
the IASB went along with under the political circumstances.

European Union banks would
have more breathing space from losses on Greek bonds if the bloc adopted a
new international accounting rule, a top standard setter said on Tuesday.

The International Accounting
Standards Board (IASB) agreed under intense pressure during the financial
crisis to soften a rule that requires banks to price traded assets at fair
value or the going market rate.

This led to huge writedowns,
sparking fire sales to plug holes in regulatory capital.

The new IFRS 9 rule would
allow banks to price assets at cost if they are being held over time.

The European Commission has
yet to sign off on the new rule for it to be effective in the 27-nation
bloc, saying it wants to see remaining parts of the rule finalized first.

Only a few years ago, Spain’s
banks were seen in some policy-making circles as a
model for the rest of the world. This may be hard to fathom now, considering
that Spain is seeking $125 billion to bail out its ailing lenders.

But back in 2008 and early 2009, Spanish regulators
were
riding highafter their country’s banks seemed to
have dodged the financial crisis with minimal losses. A big reason for their
success, the regulators said, was an accounting technique called dynamic
provisioning.

By this, they meant that Spain’s banks had set
aside rainy- day loan-loss reserves on their books during boom years. The
purpose, they said, was to build up a buffer in good times for use in bad
times.

This isn’t the way accounting standards usually
work. Normally the rules say companies can record losses, or provisions,
only when bad loans are specifically identified. Spanish regulators said
they were trying to be countercyclical, so that any declines in lending and
the broader economy would be less severe.

What’s now obvious is that Spain’s banks weren’t
reporting all of their losses when they should have, dynamically or
otherwise. One of the catalysts for last weekend’s bailout request was the
decision last month by the
Bankia (BKIA)group, Spain’s third-largest lender,
to restate its 2011 results to show a 3.3 billion-euro ($4.2 billion) loss
rather than a 40.9 million-euro profit. Looking back, we probably
should have knownSpain’s banks would end up this
way, and that their reported financial results bore no relation to reality.

Name Calling

Dynamic provisioning is a euphemism for an old
balance- sheet trick called
cookie-jar accounting. The point of the technique
is to understate past profits and shift them into later periods, so that
companies can mask volatility and bury future losses. Spain’s banks began
using the method in 2000 because their regulator, the Bank of Spain,
required them to.

“Dynamic loan loss provisions can help deal with
procyclicality in banking,” Bank of Spain’s director of financial stability,
Jesus Saurina, wrote in a July 2009
paperpublished by the World
Bank. “Their anticyclical nature enhances the
resilience of both individual banks and the banking system as a whole. While
there is no guarantee that they will be enough to cope with all the credit
losses of a downturn, dynamic provisions have proved useful in Spain during
the current financial crisis.”

The danger with the technique is it can make
companies look healthy when they are actually quite ill, sometimes for
years, until they finally deplete their
excess reservesand crash. The practice also
clashed with International Financial Reporting Standards, which Spain
adopted several years ago along with the rest of
Europe. European Union officials knew this and
let Spain proceed with its own brand of accounting anyway.

One of the more candid advocates of Spain’s
approach was Charlie McCreevy, the EU’s commissioner for financial services
from 2004 to 2010, who previously had been Ireland’s finance minister.
During an April 2009 meeting of the
monitoring boardthat oversees the
International Accounting Standards Board’s
trustees, McCreevy said he knew Spain’s banks were violating the board’s
rules. This was fine with him, he said.

“They didn’t implement IFRS, and our regulations
said from the 1st January 2005 all publicly listed companies had to
implement IFRS,” McCreevy said, according to a
transcriptof the meeting on the monitoring
board’s website. “The Spanish regulator did not do that, and he survived
this. His banks have survived this crisis better than anybody else to date.”

Ignoring Rules

McCreevy, who at the time was the chief enforcer of
EU laws affecting banking and markets, went on: “The rules did not allow the
dynamic provisioning that the Spanish banks did, and the Spanish banking
regulator insisted that they still have the dynamic provisioning. And they
did so, but I strictly speaking should have taken action against them.”

Why didn’t he take action? McCreevy said he was a
fan of dynamic provisioning. “Why am I like that? Well, I’m old enough to
remember when I was a young student that in my country that I know best,
banks weren’t allowed to publish their results in detail,” he said. “Why?
Because we felt if everybody saw the reserves, etc., it would create maybe a
run on the banks.”

So to
sum upthis way of thinking: The best system is
one that lets banks hide their financial condition from the public. Barring
that, it’s perfectly acceptable for banks to violate accounting standards,
if that’s what it takes to navigate a crisis. The proof is that Spain’s
banks survived the financial meltdown of 2008 better than most others.

European banks conjured more than £169bn of debt
into profit on their balance sheets in the third quarter of 2008, a leaked
report shows.

Money Managementhas gained exclusive access to a
report from JP Morgan, surveying 43 western European banks.

It shows an exact breakdown of which banks
increased their asset values simply by reclassifying their holdings.

Germany is Europe's largest economy, and was the
first European nation to announce that it was in recession in 2008. Based on
an exchange rate of 1 Euro to £0.89, its two largest banks, Deutsche Bank
and Commerzbank, reclassified £22.2bn and £39bn respectively.

At the same exchange rate, several major UK banks
also made the switch. RBS reclassified £27.1bn of assets, HBOS reclassified
£13.7bn, HSBC reclassified £7.6bn and Lloyds TSB changed £3.2bn. A number of
Nordic and Italian banks also switched debts to become profits.

Banks are allowed to rearrange these staggering
debts thanks to an October 2008 amendment to an International Accounting
Standards law, IAS 39. Speaking to MM, IAS board member Philippe Danjou said
that the amendment was passed in "record time".

The board received special permission to bypass
traditional due process, ushering through the amendment in a matter of days,
in order to allow banks to apply the changes to their third quarter reports.

However, it is unclear how much choice the board
actually had in the matter.

IASB chairman Sir David Tweedie was outspoken in
his opposition to the change, publicly admitting that he nearly resigned as
a result of pressure from European politicians to change the rules.

Danjou also admitted that he had mixed views on the
change, telling MM, "This is not the best way to proceed. We had to do it.
It's a one off event. I'd prefer to go back to normal due process."

While he was reluctant to point fingers at specific
politicians, Danjou admitted that Europe's "largest economies" were the most
insistent on passing the change.

As at December 2008, no major French, Portuguese,
Spanish, Swiss or Irish banks had used the amendment.

BNP Paribas, Credit Agricole, Danske Bank, Natixis
and Societe Generale were expected to reclassify their assets in the fourth
quarter of 2008.

The amendment was passed to shore up bank balance
sheets and restore confidence in the midst of the current credit crunch. But
it remains to be seen whether reclassifying major debts is an effective
tactic.

"Because the market situation was unique, events
from the outside world forced us to react quickly," said Danjou. "We do not
wish to do it too often. It's risky, and things can get missed."

Cash-strapped governments keen to replenish their
coffers and international bodies such as the OECD are stepping up efforts to
claw back revenue lost when companies shift profit overseas to cut their tax
bills.

A legal and routine practice known as transfer
pricing, whereby subsidiaries of the same company in different countries
trade with each other, is sometimes used by companies to move cash to
jurisdictions with lower tax rates, such as tax havens.

But the process can be abused by inflating the
price of goods and services traded with overseas units in order to shift
more money offshore and evade corporate taxes, and authorities now want to
toughen up their policies and close loopholes.

"Tax base erosion and profit shifting are real
problems, they need to be dealt with," Joe Andrus, head of the transfer
pricing unit at the Organisation for Economic Co-operation and Development,
which sets the international guidelines on the practice, told Reuters.

The charity Christian Aid estimates the world's
poorest countries are deprived of $160 billion in tax revenues every year by
multinationals transferring profit beyond borders. The practice also
distorts the economies of tax havens into which multinationals shift the
profits.

Joao Pedro Martins, a Lisbon-based economist and
author of a book about the Portuguese autonomous region of Madeira, says the
"exports" of hundreds of multinational subsidiaries registered in the island
have distorted its GDP at the locals' expense.

Though unemployment runs at more than 14 percent,
the island's per capita GDP is 103 percent of the EU average, compared with
78 percent for the whole of Portugal, making it the second-richest part of
the country after the capital Lisbon.

This means Madeira loses out on millions of euros
of EU support it might otherwise get under a program of grants for regions
with per capita GDP of less than 75 percent of the European average, Martins
says.

The OECD champions a set of guidelines known as the
"arm's-length" method which permits transfer pricing only when transactions
between affiliates at are struck at market rates.

However, organizations can skirt this rule through
trade in intangible assets or services where pricing can be arbitrary and
much harder to benchmark against a global market rate.

"There is no such thing as an arms length price.
The idea of the arms length price is fundamentally flawed from the outset,"
says John Christensen, director at pressure group Tax Justice Network which
campaigns against aggressive tax avoidance.

The Nordic state is battening down the hatches for
a full-blown currency crisis as tensions in the eurozone mount and has said
it will not tolerate further bail-out creep or fiscal union by stealth.

“We have to face openly the possibility of a
euro-break up,” said Erkki Tuomioja, the country’s veteran foreign minister
and a member of the Social Democratic Party, one of six that make up the
country’s coalition government.

“It is not something that anybody — even the True
Finns [eurosceptic party] — are advocating in Finland, let alone the
government. But we have to be prepared,” he told The Daily Telegraph.

“Our officials, like everybody else and like every
general staff, have some sort of operational plan for any eventuality.”

Mr Tuomioja’s intervention is the bluntest warning
to date by a senior eurozone minister. As he discussed the crisis, the
minister had a copy of the Economist on his desk. It had a picture of Angela
Merkel, the German Chancellor, reading a fictitious report entitled “How to
break up the euro”, with a caption: “Tempted, Angela?”

“This is what people are thinking about
everywhere,” said Mr Tuomioja. “But there is a consensus that a eurozone
break-up would cost more in the short-run or medium-run than managing the
crisis.

“But let me add that the break-up of the euro does
not mean the end of the European Union. It could make the EU function
better,” he said, describing the dash for monetary union in the 1990s as a
vaulting political leap in defiance of economic gravity. Finland has emerged
as the toughest member of the eurozone’s creditor bloc as it tries to hold
together a motley coalition. It has insisted on collateral from both Greece
and Spain in exchange for rescue loans.

The coalition government is on thin ice as voters
peel away to eurosceptic parties. The True Finns shattered the political
order in last year’s election with 19pc support. “Taxpayers here are
extremely angry,” said Timo Soini, the True Finn leader.

“There are no rules on how to leave the euro but it
is only a matter of time. Either the south or the north will break away
because this currency straitjacket is causing misery for millions and
destroying Europe’s future.

“It is a total catastrophe. We are going to run out
of money the way we are going. But nobody in Europe wants to be first to get
out of the euro and take all the blame,” he said.

Like other member states, Finland has a veto that
could be used to block any new bail-out measures. However, unlike some
states, its parliament would have to approve each future measure of the
eurozone rescue, including a full bail-out of Spain.

The issue of euro break-up may come to a head in
October as EU-IMF Troika inspectors report back on Greek bail-out
compliance. Pleas from Athens for two extra years to stretch out its
austerity regime have run into fierce resistance from creditor powers.

“It is up to Greeks whether they want to stay in
the euro,” said Mr Tuomioja. “We cannot force Greece out. We can cut off
lending and that would lead to a default. Then we could speculate whether
that would entail getting out of the euro. Nobody knows if it could be
contained,” he said. Mr Tuomioja said Finland would block attempts to strip
the European Stability Mechanism (ESM) or bail-out fund of its senior status
at the top of the credit ladder, a move that could greatly complicate
efforts to lure investors back into Spanish and Italian bonds. “The ESM
loans have priority. That is a red line for us. We are very concerned that
the rules of the ESM seem to be changing.”

He voiced deep suspicion of plans by a “gang of
four” EU insiders — including the European Central Bank’s Mario Draghi — to
ensnare member states into some form of fiscal union. “I don’t trust these
people,” he said.

Mr Draghi said two weeks ago that the issue of
seniority would be “addressed” as part of his twin-pronged plan for the ECB
and ESM to buy bonds in concert. A number of EU leaders and officials
claimed there had been a deal on the ESM’s seniority status at an EU summit
in late June. Finland, Holland, and Germany all deny this.

The warnings on the ESM were echoed by Miapetra
Kumpula-Natri, chairman of the Finnish parliament’s Grand Committee on
Europe, who said bail-out fatigue is nearing its limit.

“Our law passed this summer says the ESM has the
same priority as the IMF. There was a clear understanding on this. Any
change would require a new law passed by the whole parliament, and this
would be very difficult because the risks would be much higher.”

The issue of EU senior status has become an
extremely sensitive one for markets after the ECB and EU creditors refused
to share losses from Greece’s debt restructuring, in which pension funds,
insurers, and banks lost 75pc.

Continued in article

Jensen Comment
I think Finland is wondering why it did not follow the lead of Sweden, Norway,
Denmark, and the United Kingdom in refusing to join the Eurozone in the first
place ---
http://en.wikipedia.org/wiki/Eurozone

Three Portage County residents are accused of
cashing Social Security checks of a relative who has been missing for 30
years and is presumed dead, and authorities are investigating to see whether
her remains are buried on her wooded property.

If Marie Jost is still alive she'd be 100 years
old. But authorities now suspect she died in about 1982, and they're
accusing her son, daughter and son-in-law of continuing to cash her
government checks in her absence.

Investigators believe Jost might be buried on her
Amherst property. Sheriff's Capt. Dale O'Kray said Tuesday that cadaver dogs
have hit upon the scent of human remains, and authorities are using heavy
machinery to explore the property and dig for evidence.

"There's no indication she's been seen in the last
25 years and we have to have a starting point for where she might be,"
O'Kray said.

Charles T. Jost, 66; Delores M. Disher, 69; and
Ronald Disher, 71, each face four felony charges including being party to
the crimes of theft and mail fraud. The charges carry a maximum combined
penalty of 68 years in prison and a $310,000 fine.

The Social Security Administration had sent three
letters to Jost's home to verify she was still alive. After the third letter
was sent, a man who identified himself as her son called to say Jost wasn't
available.

The agency then contacted Portage County
authorities last month asking that deputies check on her. Deputies went to
her property where Charles Jost allegedly

told them Marie Jost and his 74-year-old brother
Theodore "were riding in a vehicle someplace," according to the criminal
complaint.

When a deputy asked for permission to search the
property, Charles Jost allegedly grew agitated and asked them to leave. The
deputy then asked whether Marie Jost was still alive, and Charles Jost said
he would talk to his lawyer and ended the conversation, the complaint said.

Authorities obtained a search warrant and gathered
evidence, but they haven't found anything to indicate whether Marie Jost is
alive or dead, O'Kray said.

There's not a real house on the 3-acre property.
Charles Jost lives in a tarp-covered shack there, and four to five sheds are
filled with years' worth of garbage, O'Kray said.

"It's basically a 'Hoarders' episode gone bad," he
said. "We have about 400 garbage bags of junk we had to remove to search the
living areas."

During an initial court appearance Monday a judge
ordered that Charles Jost undergo a competency evaluation. A message left
for Jost's defense attorney Tuesday was not immediately returned.

Neighbors told authorities they had never seen an
elderly woman at Charles Jost's home.

A Social Security agent said Marie Jost had not
used her Medicare benefits since 1980 when she had a stroke. The agent said
Jost had been sent Social Security payments of more than $175,000 since she
had made a Medicaid claim.

Prosecutors say the Social Security checks were
endorsed with an X, along with the printed names of Charles and Theodore
Jost.

My latest column @Forbes is about the most recent
futures industry fraud case, PFGBest. PFGBest is another reason why the
industry’s poor business environment, wracked with a crisis of confidence
after MF Global, just got much worse.

PFGBest has a long story behind it. CEO Russell
Wasendorf, who admitted to a twenty year fraud on customers in his suicide
attempt note, started the firm in 1980, according to
MarketsWiki, an online open source knowledge base
for current and historical information about the global exchange traded
capital, derivatives, environmental and related OTC markets. The site is run
by Chicagoan John Lothian who publishes a subscription-only industry
newsletter.

PFGBest (formerly Peregrine Financial Group, Inc. – PFG), founded in
1980, is a privately
held non-clearing
registered Futures
Commission Merchant. PFGBest has branch offices in Chicago;
Bloomfield and New York City, NY; Camarillo and Mission Viejo, CA; Cedar
Falls, IA; Scottsdale, AZ; Altamonte Springs, FL, and McKinny, TX. It
serves Canada through an office in Toronto, and its Asian division
offers brokerage
and other services to clients who speak various Chinese dialects. The company
also has a network of brokers
spanning the globe.

It is safe to say that Mr. Wasendorf did not
get the pick of the litter when the customer business, which cleared at
RB&H, was split up between RB&H and Peregrine. First Commercial was a
party to 75 CFTC reparation cases and a respondent to 10 NFA
arbitrations prior to their registration finally being revoked by the
NFA in 1996.

Mr. Wasendorf and his firm Wasendorf & Son was
also involved with another CME-related firm that had its own unhappy
ending, GNP Commodities, headed by one-time CME Chairman Brian Monieson.
GNP was the party to 117 CFTC reparation cases and five NFA arbitration
awards. GNP also had two NFA, three CFTC and six exchange regulatory
actions against it before its registration was revoked.

Of course Alaron also had its problems. It was
a party to 55 CFTC reparation cases, was a respondent to 12 NFA
arbitration cases and two NFA, two CFTC and 15 exchange regulatory
actions. By contrast, Peregrine was party to 38 CFTC reparation cases
and 31 NFA arbitration awards, as well as four NFA and one CFTC
regulatory actions.

Larry Rosenberg went on to head Lake
Shore, which was also closed for fraud. First Commerical was also
invested in by backers of the L & S firm, Glenn Laken and Bob Schialasi.
Laken served time while indicted and jailed for securities fraud under
NY RICO statutes in 2000. First Commercial owned 49% of Jack Sandner’s RB
& H. Unsubstantiated reports say RB & H was also backed by investors
Sheikh Abdulla Backesh who is connected to the BCCI Bank $ 10 Billion
fraud and had a minority stake and
Talat Othman, of Arlington
Heights’ Dearborn Financial.

That’s how the futures business works in
Chicago. Firms run into trouble and stronger, better capitalized or
sometimes just better connected firms picked over the carcasses for the
best meat and take them over for a bargain price at the regulators’
request. Not much different from what the Treasury did to some financial
institutions during the 2008 financial crisis.

What’s interesting for me in the PFGBest
case is
the use of a small, one-woman shop as the auditor. PFG
Best has a subsidiary that was registered with the SEC. As such they
were required to use an auditor that is registered with the PCAOB.
Jeannie Veraja-Snelling registered her firm with the PCAOB and she had
no marks on her record with the Illinois professional regulation
authority before now.

The chief executive of Peregrine Financial Group
Inc. faces a maximum 50 years in prison under a plea agreement he signed
with federal prosecutors.

Under the agreement, Russell Wasendorf Sr. would
plead guilty to charges of embezzlement and mail fraud alongside two counts
of lying to government regulators, assistant U.S. attorneys said in a Cedar
Rapids, Iowa, court Tuesday.

The development comes more than two months after
Mr. Wasendorf, founder of Peregrine and a business leader in his adopted
hometown of Cedar Falls, attempted suicide outside his firm's headquarters,
leaving behind what authorities called a confession detailing a yearslong
scheme to defraud his investors. Civil charges were brought by regulators
against Mr. Wasendorf and Peregrine, and the firm filed for bankruptcy July
10.

A court-appointed trustee this week said the
futures and currency brokerage has a $190 million shortfall in funds, and
that its customers wouldn't get back all of the money they entrusted to
Peregrine.

The disclosure of Mr. Wasendorf's potential plea
deal came at a detention hearing Tuesday following Mr. Wasendorf's request
to be released from jail.

Judge Jon Scoles said in a court document Tuesday
that he would consider whether or not to grant bail that would release Mr.
Wasendorf from the Linn County Correctional Center, where Mr. Wasendorf has
been held since he was arrested July 13.

Prosecutors said Mr. Wasendorf agreed to admit
guilt to a yearslong scheme in which he used customer money to cushion
Peregrine's finances and pay other expenses, while covering his tracks by
falsifying bank documents. Peter Deegan, an assistant U.S. attorney
prosecuting the case, declined further comment.

Jane Kelly, the federal public defender
representing Mr. Wasendorf, didn't respond to a request for comment.

Last month Mr. Wasendorf pleaded not guilty to 31
charges of misleading government regulators. He has cooperated with the
investigation, however, spending hours with authorities probing Peregrine's
finances and answering questions, according to a legal filing by the
receiver responsible for liquidating Mr. Wasendorf's personal estate.

A statutory maximum sentence of 50 years was seen
to amount to a life sentence for Mr. Wasendorf, who is 64 years old, and
some affected by the Peregrine collapse said they looked forward to a
resolution of the case.

Huron Consulting Group Inc., a Chicago-based
consulting company founded by a group of former Arthur Andersen LLP partners
after the accounting firm's 2002 demise, has agreed to pay $1 million to
settle Securities and Exchange Commission allegations that it cooked its
books.

he deal caps a remarkable act of corporate
self-immolation. One of Huron's main businesses had been providing
forensic-accounting advice to other companies, including those under SEC
investigation for accounting fraud. Then in 2009 Huron restated more than
three years of its financial reports to correct accounting violations, which
reduced its earnings by $56 million. The company sold part of its
disputes-and-investigations practice in 2010 and shuttered the rest.

The SEC, which disclosed the accord in a press
release late Thursday, also reached settlement deals with Huron's former
chief financial officer, Gary Burge, and its former chief accounting
officer, Wayne Lipski. They agreed to pay almost $300,000 to resolve the
SEC's claims against them.

Per the usual formalities, the defendants neither
admitted nor denied anything. Unlike the conviction against Arthur Andersen
for obstructing the government's investigation of Enron Corp., the SEC's
order against Huron in this case won't be overturned.

Preliminary estimates released by the U.S.
Department of Labor find that, in 2009, states made more than $7.1 billion
in overpayments in unemployment insurance, up from $4.2 billion the year
before. The total amount of unemployment benefits paid in 2009 was $76.8
billion, compared to $41.6 billion in 2008.

Fraud accounted for $1.55 billion in estimated
overpayments last year, while errors by state agencies were blamed for $2.27
billion, according to the Labor Department. The department's final report
will be released next month.

Some of the overpayments likely can be traced back
to the overwhelming workloads facing state employment agencies during the
recession, said George Wentworth, a policy analyst for the National
Employment Law Project.

"You've got a system that's been under siege like
the unemployment insurance system has been for the last two years,"
Wentworth said. "You've got a lot of new staff coming into the system,
there's been a lot of federal extensions [to unemployment insurance
benefits] that have had to be programmed in and so on. There's just been a
lot of change that states have had to handle. ... I just think the volume
and the new staff have made the systems more susceptible to error."

The Humane Society's TV adds with the adorable and sad dogs and cats are
probably among the most successful advertisements on television
But are they misleading in terms of not giving more than 1% of the donations to
Humane Society shelters?
I'm always suspicious of these hard-sell fund raisers.
"Consumer group wants probe of Humane Society ads," WPXI Pittsburgh, July
13, 2012 ---
http://www.wpxi.com/news/news/local/consumer-group-wants-probe-humane-society-ads/nPsXB/

An organization wants attorneys general in
Pennsylvania and 11 other states to investigate whether advertisements by
the Humane Society of the United States violate laws by implying that money
from donors supports animal shelters.

HumaneWatch, a nonprofit project of the
Washington-based Center for Consumer Freedom, released a report on Thursday
claiming that the Humane Society gives 1 percent or less of its income to
local animal shelters, despite ads showing animals in shelters.

“Consistently, there is a disconnect between what
they use to raise money and what they spend that money on,” said Justin
Wilson, senior research analyst at the Center for Consumer Freedom.

Humane Society of the United States spokeswoman
Stephanie Twinings said the Center for Consumer Freedom represents food
industry interests in Washington and is more interested in stopping the
Humane Society’s lobbying efforts than steering more money to shelters.

“This is all just their desperate attempts to pull
fundraising away from us because we’re effective in getting regulations
changed for the food industry,” she said.

Nils Fredricksen, spokesman for Pennsylvania
Attorney General Linda Kelly, said his office neither confirms nor denies
the existence of any investigations, but said Kelly reads and responds to
any petition that crosses her desk.

“There is a belief in the public that the Humane
Society of the United States is the mothership, so to speak, and that all
the local humane societies ... must answer to them. That’s not true,” said
Gretchen Fieser, spokeswoman for the Western Pennsylvania Humane Society in
the North Side.

Local shelters and humane societies are concerned
with animal welfare, rather than animal rights, food-industry issues or
national campaigns, she said.

“(HSUS) can get better cages for chickens in
factory farms,” Fieser said. “When we get chickens, they were someone’s pet
or a science project that got too big.”

The Western Pennsylvania Humane Society on the
North Side is in no way affiliated with the national group.

Jensen Comment
Obviously you can't adopt a pet like we "adopted" a young girl in Latin America
by donating cash each month. The Human Society may send you a picture of your
pet, but most likely it is either adopted for real by a loving family or
euthanized since the Humane Society does not generally provide facilities for
the long-term life of a dog or cat.

A few weeks ago, TechCrunch published a piece
arguing software is better at investing than 99% of human investment
advisors. That post, titled
Thankfully, Software Is Eating The Personal Investing World,
pointed out the advantages of engineering-driven
software solutions versus emotionally driven human judgment. Perhaps not
surprisingly, some commenters (including some financial advisors) seized the
moment to call into question one of the foundations of software-based
investing, Modern Portfolio Theory.

Given the doubts raised by a small but vocal
chorus, it’s worth spending some time to ask if we need a new investing
paradigm and if so, what it should be. Answering that question helps show
why MPT still is the best investment methodology out there; it enables the
automated, low-cost investment management offered by a new wave of Internet
startups including Wealthfront
(which I advise),
Personal Capital,
Future Advisor
and SigFig.

Don’t these unknown unknowns mean we must
develop a new approach to investing?

Let’s begin by briefly laying out the key insights
of MPT.

MPT is based in part on the assumption that most
investors don’t like risk and need to be compensated for bearing it. That
compensation comes in the form of higher average returns. Historical data
strongly supports this assumption. For example, from 1926 to 2011 the
average (geometric) return on U.S. Treasury Bills was 3.6%. Over the same
period the average return on large company stocks was 9.8%; that on small
company stocks was 11.2% ( See 2012 Ibbotson Stocks, Bonds, Bills and
Inflation (SBBI) Valuation Yearbook, Morningstar, Inc., page 23. ). Stocks,
of course, are much riskier than Treasuries, so we expect them to have
higher average returns — and they do.

One of MPT’s key insights is that while investors
need to be compensated to bear risk, not all risks are rewarded. The market
does not reward risks that can be “diversified away” by holding a bundle of
investments, instead of a single investment. By recognizing that not all
risks are rewarded, MPT helped establish the idea that a diversified
portfolio can help investors earn a higher return for the same amount of
risk.

To understand which risks can be diversified away,
and why, consider Zynga. Zynga hit $14.69 in March and has since dropped to
less than $2 per share. Based on what’s happened over the past few months,
the major risks associated with Zynga’s stock are things such as delays in
new game development, the fickle taste of consumers and changes on Facebook
that affect users’ engagement with Zynga’s games.

For company insiders, who have much of their wealth
tied up in the company, Zynga is clearly a risky investment. Although those
insiders are exposed to huge risks, they aren’t the investors who determine
the “risk premium” for Zynga. (A stock’s risk premium is the extra return
the stock is expected to earn that compensates for the stock’s risk.)

Rather, institutional funds and other large
investors establish the risk premium by deciding what price they’re willing
to pay to hold Zynga in their diversified portfolios. If a Zynga game is
delayed, and Zynga’s stock price drops, that decline has a miniscule effect
on a diversified shareholder’s portfolio returns. Because of this, the
market does not price in that particular risk. Even the overall turbulence
in many Internet stocks won’t be problematic for investors who are well
diversified in their portfolios.

Modern Portfolio Theory focuses on constructing
portfolios that avoid exposing the investor to those kinds of unrewarded
risks. The main lesson is that investors should choose portfolios that lie
on the Efficient Frontier, the mathematically defined curve that describes
the relationship between risk and reward. To be on the frontier, a portfolio
must provide the highest expected return (largest reward) among all
portfolios having the same level of risk. The Internet startups construct
well-diversified portfolios designed to be efficient with the right
combination of risk and return for their clients.

Now let’s ask if anything in the past five years
casts doubt on these basic tenets of Modern Portfolio Theory. The answer is
clearly, “No.” First and foremost, nothing has changed the fact that there
are many unrewarded risks, and that investors should avoid these risks. The
major risks of Zynga stock remain diversifiable risks, and unless you’re
willing to trade illegally on inside information about, say, upcoming
changes to Facebook’s gaming policies, you should avoid holding a
concentrated position in Zynga.

The efficient frontier is still the desirable place
to be, and it makes no sense to follow a policy that puts you in a position
well below that frontier.

Most of the people who say that “diversification
failed” in the financial crisis have in mind not the diversification gains
associated with avoiding concentrated investments in companies like Zynga,
but the diversification gains that come from investing across many different
asset classes, such as domestic stocks, foreign stocks, real estate and
bonds. Those critics aren’t challenging the idea of diversification in
general – probably because such an effort would be nonsensical.

True, diversification across asset classes didn’t
shelter investors from 2008’s turmoil. In that year, the S&P 500 index fell
37%, the MSCI EAFE index (the index of developed markets outside North
America) fell by 43%, the MSCI Emerging Market index fell by 53%, the Dow
Jones Commodities Index fell by 35%, and the Lehman High Yield Bond Index
fell by 26%. The historical record shows that in times of economic distress,
asset class returns tend to move in the same direction and be more highly
correlated. These increased correlations are no doubt due to the increased
importance of macro factors driving corporate cash flows. The increased
correlations limit, but do not eliminate, diversification’s value. It would
be foolish to conclude from this that you should be undiversified. If a seat
belt doesn’t provide perfect protection, it still makes sense to wear one.
Statistics show it’s better to wear a seatbelt than to not wear one.
Similarly, statistics show diversification reduces risk, and that you are
better off diversifying than not.

Timing the market

The obvious question to ask anyone who insists
diversification across asset classes is not effective is: What is the
alternative? Some say “Time the market.” Make sure you hold an asset class
when it is earning good returns, but sell as soon as things are about to go
south. Even better, take short positions when the outlook is negative. With
a trustworthy crystal ball, this is a winning strategy. The potential gains
are huge. If you had perfect foresight and could time the S&P 500
on a daily basis, you could have turned $1,000 on Jan. 1, 2000, into
$120,975,000 on Dec. 31, 2009, just by going in and out of the market. If
you could also short the market when appropriate, the gains would have been
even more spectacular!

Sometimes, it seems someone may have a fairly
reliable crystal ball. Consider John Paulson, who in 2007 and 2008 seemed so
prescient in profiting from the subprime market’s collapse. It appears,
however, that Mr. Paulson’s crystal ball became less reliable after his
stunning success in 2007. His Advantage Plus fund experienced more than a
50% loss in 2011. Separating luck from skill is often difficult.

Some people try to come up with a way to time the
market based on historical data. In fact a large number of strategies will
work well “in the back test.” The question is whether any system is reliable
enough to use for future investing.

There are at least three reasons to be cautious
about substituting a timing system for diversification.

First, a timing system that does not work can
impose significant transaction costs (including avoidable adverse tax
consequences) on the investor for no gain.

Second, an ill-founded timing strategy
generally exposes the investor to risk that is unrewarded. In other
words, it puts the investor below the frontier, which is not a good
place to be.

Third, a timing system’s success may create
the seeds of its own destruction. If too many investors blindly follow
the strategy, prices will be driven to erase any putative gains that
might have been there, turning the strategy into a losing proposition.
Also, a timing strategy designed to “beat the market” must involve
trading into “good” positions and away from “bad” ones. That means there
must be a sucker (or several suckers) available to take on the other
(losing) sides. (No doubt in most cases each party to the trade thinks
the sucker is on the other side.)

Black Swans

What about those Black Swans? Doesn’t MPT ignore
the possibility that we can be surprised by the unexpected? Isn’t it
impossible to measure risk when there are unknown unknowns?

Most people recognize that financial markets are
not like simple games of chance where risk can be quantified precisely. As
we’ve seen (e.g., the “Black Monday” stock market crash of 1987 and the
“flash crash” of 2010), the markets can produce extreme events that hardly
anyone contemplated as a possibility. As opposed to poker, where we always
draw from the same 52-card deck, in financial markets, asset returns are
drawn from changing distributions as the world economy and financial
relationships change.

Some Black Swan events turned out to have limited
effects on investors over the long term. Although the market dropped
precipitously in October 1987, it was close to fully recovered in June 1988.
The flash crash was confined to a single day.
This is not to say that all “surprise” events are transitory. The Great
Depression followed the stock market crash of 1929, and the effects of the
financial crisis in 2007 and 2008 linger on five years later.

The question is, how should we respond to
uncertainties and Black Swans? One sensible way is to be more diligent in
quantifying the risks we can see. For example, since extreme events don’t
happen often, we’re likely to be misled if we base our risk assessment on
what has occurred over short time periods. We shouldn’t conclude that just
because housing prices haven’t gone down over 20 years that a housing
decline is not a meaningful risk. In the case of natural disasters like
earthquakes, tsunamis, asteroid strikes and solar storms, the long run could
be very long indeed. While we can’t capture all risks by looking far back in
time, taking into account long-term data means we’re less likely to be
surprised.

Some people suggest you should respond to the risk
of unknown unknowns by investing very conservatively. This means allocating
most of the portfolio to “safe assets” and significantly reducing exposure
to risky assets, which are likely to be affected by Black Swan surprises.
This response is consistent with MPT. If you worry about Black Swans, you
are, for all intents and purposes, a very risk-averse investor. The MPT
portfolio position for very risk-averse investors is a position on the
efficient frontier that has little risk.

The cost of investing in a low-risk position is a
lower expected return (recall that historically the average return on stocks
was about three times that on U.S. Treasuries), but maybe you think that’s a
price worth paying. Can everyone take extremely conservative positions to
avoid Black Swan risk? This clearly won’t work, because some investors must
hold risky assets. If all investors try to avoid Black Swan events, the
prices of those risky assets will fall to a point where the forecasted
returns become too large to ignore.

Continued in article

Jensen Comment
All quant theories and strategies in finance are based upon some foundational
assumptions that in rare instances turn into the
Achilles'
heel of the entire superstructure. The classic example is the wonderful
theory and arbitrage strategy of Long Term Capital Management (LTCM) formed by
the best quants in finance (two with Nobel Prizes in economics). After
remarkable successes one nickel at a time in a secret global arbitrage strategy
based heavily on the Black-Scholes Model, LTCM placed a trillion dollar bet that
failed dramatically and became the only hedge fund that nearly imploded all of
Wall Street. At a heavy cost, Wall Street investment bankers pooled billions of
dollars to quietly shut down LTCM ---
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

So what was the Achilles heal of the arbitrage strategy of LTCM? It was an
assumption that a huge portion of the global financial market would not collapse
all at once. Low and behold, the Asian financial markets collapsed all at once
and left LTCM naked and dangling from a speculative cliff.

There is a tremendous (one of the best
videos I've ever seen on the Black-Scholes Model) PBS Nova video called "Trillion Dollar Bet" explaining why LTCM
collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/
This video is in the media libraries on most college campuses. I highly
recommend showing this video to students. It is extremely well done and
exciting to watch.

The principal
policy issue arising out of the events surrounding the near collapse of LTCM
is how to constrain excessive leverage. By increasing the chance that
problems at one financial institution could be transmitted to other
institutions, excessive leverage can increase the likelihood of a general
breakdown in the functioning of financial markets. This issue is not limited
to hedge funds; other financial institutions are often larger and more
highly leveraged than most hedge funds.

The video and above reports, however, do not delve into the tax shelter
pushed by Myron Scholes and his other LTCM partners. A nice summary of the tax
shelter case with links to other documents can be found at
http://www.cambridgefinance.com/CFP-LTCM.pdf

The classic and enormous scandal was
Long Term Capital led by Nobel Prize winning Merton and Scholes (actually the
blame is shared with their devoted doctoral students). There is a tremendous
(one of the best videos I've ever seen on the Black-Scholes Model) PBS Nova
video ("Trillion Dollar Bet") explaining why LTC collapsed. Go to
http://www.pbs.org/wgbh/nova/stockmarket/

Another illustration of the Achilles' heel of a popular mathematical theory
and strategy is the 2008 collapse mortgage-backed CDO financial risk bonds based
upon David Li's Gaussian copula function of risk diversification in portfolios.
The Achilles' heel was the assumption that the real estate bubble would not
burst to a point where millions of subprime mortgages would all go into default
at roughly the same time.

"For five years, Li's formula, known as a
Gaussian copula function, looked like an unambiguously positive
breakthrough, a piece of financial technology that allowed hugely
complex risks to be modeled with more ease and accuracy than ever
before. With his brilliant spark of mathematical legerdemain, Li made it
possible for traders to sell vast quantities of new securities,
expanding financial markets to unimaginable levels.

His method was adopted by everybody from bond
investors and Wall Street banks to ratings agencies and regulators. And
it became so deeply entrenched—and was making people so much money—that
warnings about its limitations were largely ignored.

Then the model fell apart." The article goes on to show that correlations
are at the heart of the problem.

"The reason that ratings agencies and investors
felt so safe with the triple-A tranches was that they believed there was
no way hundreds of homeowners would all default on their loans at the
same time. One person might lose his job, another might fall ill. But
those are individual calamities that don't affect the mortgage pool much
as a whole: Everybody else is still making their payments on time.

But not all calamities are individual, and
tranching still hadn't solved all the problems of mortgage-pool risk.
Some things, like falling house prices, affect a large number of people
at once. If home values in your neighborhood decline and you lose some
of your equity, there's a good chance your neighbors will lose theirs as
well. If, as a result, you default on your mortgage, there's a higher
probability they will default, too. That's called correlation—the degree
to which one variable moves in line with another—and measuring it is an
important part of determining how risky mortgage bonds are."

I would highly recommend reading the entire thing that gets much more
involved with the
actual formula etc.

The
“math error” might truly be have been an error or it might have simply been a
gamble with what was perceived as miniscule odds of total market failure.
Something similar happened in the case of the trillion-dollar disastrous 1993
collapse of Long Term Capital Management formed by Nobel Prize winning
economists and their doctoral students who took similar gambles that ignored the
“miniscule odds” of world market collapse -- -
http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

The rhetorical question is whether the failure is ignorance in model building or
risk taking using the model?

ROBERT RUBIN was Bill Clinton’s treasury
secretary. He has worked at the top of Goldman Sachs and Citigroup. But he
made arguably the single most influential decision of his long career in
1983, when as head of risk arbitrage at Goldman he went to the MIT Sloan
School of Management in Cambridge, Massachusetts, to hire an economist
called Fischer Black.

A decade earlier Myron Scholes, Robert
Merton and Black had explained how to use share prices to calculate the
value of derivatives. The Black-Scholes options-pricing model was more than
a piece of geeky mathematics. It was a manifesto, part of a revolution that
put an end to the anti-intellectualism of American finance and transformed
financial markets from bull rings into today’s quantitative powerhouses.
Yet, in a roundabout way, Black’s approach also led to some of the late
boom’s most disastrous lapses.

Derivatives markets are not new, nor are
they an exclusively Western phenomenon. Mr Merton has described how Osaka’s
Dojima rice market offered forward contracts in the 17th century and
organised futures trading by the 18th century. However, the growth of
derivatives in the 36 years since Black’s formula was published has taken
them from the periphery of financial services to the core.

In “The Partnership”, a history of Goldman
Sachs, Charles Ellis records how the derivatives markets took off. The
International Monetary Market opened in 1972; Congress allowed trade in
commodity options in 1976; S&P 500 futures launched in 1982, and options on
those futures a year later. The Chicago Board Options Exchange traded 911
contracts on April 26th 1973, its first day (and only one month before
Black-Scholes appeared in print). In 2007 the CBOE’s volume of contracts
reached almost 1 trillion.

Trading has exploded partly because
derivatives are useful. After America came off the gold standard in 1971,
businesses wanted a way of protecting themselves against the movements in
exchange rates, just as they sought protection against swings in interest
rates after Paul Volcker, Mr Greenspan’s predecessor as chairman of the Fed,
tackled inflation in the 1980s. Equity options enabled investors to lay off
general risk so that they could concentrate on the specific types of
corporate risk they wanted to trade.

The other force behind the explosion in
derivatives trading was the combination of mathematics and computing. Before
Black-Scholes, option prices had been little more than educated guesses. The
new model showed how to work out an option price from the known price-behaviour
of a share and a bond. It is as if you had a formula for working out the
price of a fruit salad from the prices of the apples and oranges that went
into it, explains Emanuel Derman, a physicist who later took Black’s job at
Goldman. Confidence in pricing gave buyers and sellers the courage to pile
into derivatives. The better that real prices correlate with the unknown
option price, the more confidently you can take on any level of risk. “In a
thirsty world filled with hydrogen and oxygen,” Mr Derman has written,
“someone had finally worked out how to synthesise H2O.”

Poetry in Brownian motion Black-Scholes is
just a model, not a complete description of the world. Every model makes
simplifications, but some of the simplifications in Black-Scholes looked as
if they would matter. For instance, the maths it uses to describe how share
prices move comes from the equations in physics that describe the diffusion
of heat. The idea is that share prices follow some gentle random walk away
from an equilibrium, rather like motes of dust jiggling around in Brownian
motion. In fact, share-price movements are more violent than that.

Over the years the “quants” have found
ways to cope with this—better ways to deal with, as it were, quirks in the
prices of fruit and fruit salad. For a start, you can concentrate on the
short-run volatility of prices, which in some ways tends to behave more like
the Brownian motion that Black imagined. The quants can introduce sudden
jumps or tweak their models to match actual share-price movements more
closely. Mr Derman, who is now a professor at New York’s Columbia University
and a partner at Prisma Capital Partners, a fund of hedge funds, did some of
his best-known work modelling what is called the “volatility smile”—an
anomaly in options markets that first appeared after the 1987 stockmarket
crash when investors would pay extra for protection against another imminent
fall in share prices.

The fixes can make models complex and
unwieldy, confusing traders or deterring them from taking up new ideas.
There is a constant danger that behaviour in the market changes, as it did
after the 1987 crash, or that liquidity suddenly dries up, as it has done in
this crisis. But the quants are usually pragmatic enough to cope. They are
not seeking truth or elegance, just a way of capturing the behaviour of a
market and of linking an unobservable or illiquid price to prices in traded
markets. The limit to the quants’ tinkering has been not mathematics but the
speed, power and cost of computers. Nobody has any use for a model which
takes so long to compute that the markets leave it behind.

The idea behind quantitative finance is to
manage risk. You make money by taking known risks and hedging the rest. And
in this crash foreign-exchange, interest-rate and equity derivatives models
have so far behaved roughly as they should.

A muddle of mortgages Yet the idea behind
modelling got garbled when pools of mortgages were bundled up into
collateralised-debt obligations (CDOs). The principle is simple enough.
Imagine a waterfall of mortgage payments: the AAA investors at the top catch
their share, the next in line take their share from what remains, and so on.
At the bottom are the “equity investors” who get nothing if people default
on their mortgage payments and the money runs out.

Despite the theory, CDOs were hopeless, at
least with hindsight (doesn’t that phrase come easily?). The cash flowing
from mortgage payments into a single CDO had to filter up through several
layers. Assets were bundled into a pool, securitised, stuffed into a CDO,
bits of that plugged into the next CDO and so on and on. Each source of a
CDO had interminable pages of its own documentation and conditions, and a
typical CDO might receive income from several hundred sources. It was a
lawyer’s paradise.

This baffling complexity could hardly be
more different from an equity or an interest rate. It made CDOs impossible
to model in anything but the most rudimentary way—all the more so because
each one contained a unique combination of underlying assets. Each CDO would
be sold on the basis of its own scenario, using central assumptions about
the future of interest rates and defaults to “demonstrate” the payouts over,
say, the next 30 years. This central scenario would then be “stress-tested”
to show that the CDO was robust—though oddly the tests did not include a 20%
fall in house prices.

This was modelling at its most feeble.
Derivatives model an unknown price from today’s known market prices. By
contrast, modelling from history is dangerous. There was no guarantee that
the future would be like the past, if only because the American housing
market had never before been buoyed up by a frenzy of CDOs. In any case,
there are not enough past housing data to form a rich statistical picture of
the market—especially if you decide not to include the 1930s nationwide fall
in house prices in your sample.

Neither could the models take account of
falling mortgage-underwriting standards. Mr Rajan of the University of
Chicago says academic research suggests mortgage originators, keen to
automate their procedures, stopped giving potential borrowers lengthy
interviews because they could not easily quantify the firmness of someone’s
handshake or the fixity of their gaze. Such things turned out to be better
predictors of default than credit scores or loan-to-value ratios, but the
investors at the end of a long chain of securities could not monitor lending
decisions.

The issuers of CDOs asked rating agencies
to assess their quality. Although the agencies insist that they did a
thorough job, a senior quant at a large bank says that the agencies’ models
were even less sophisticated than the issuers’. For instance, a BBB tranche
in a CDO might pay out in full if the defaults remained below 6%, and not at
all once they went above 6.5%. That is an all-or-nothing sort of return,
quite different from a BBB corporate bond, say. And yet, because both shared
the same BBB rating, they would be modelled in the same way.

Issuers like to have an edge over the
rating agencies. By paying one for rating the CDOs, some may have laid
themselves open to a conflict of interest. With help from companies like
Codefarm, an outfit from Brighton in Britain that knew the agencies’ models
for corporate CDOs, issuers could build securities with any risk profile
they chose, including those made up from lower-quality ingredients that
would nevertheless win AAA ratings. Codefarm has recently applied for
administration.

There is a saying on Wall Street that the
test of a product is whether clients will buy it. Would they have bought
into CDOs had it not been for the dazzling performance of the quants in
foreign-exchange, interest-rate and equity derivatives? There is every sign
that the issuing banks believed their own sales patter. The banks so liked
CDOs that they held on to a lot of their own issues, even when the idea
behind the business had been to sell them on. They also lent buyers much of
the money to bid for CDOs, certain that the securities were a sound
investment. With CDOs in deep trouble, the lenders are now suffering.

Modern finance is supposed to be all about
measuring risks, yet corporate and mortgage-backed CDOs were a leap in the
dark. According to Mr Derman, with Black-Scholes “you know what you are
assuming when you use the model, and you know exactly what has been swept
out of view, and hence you can think clearly about what you may have
overlooked.” By contrast, with CDOs “you don’t quite know what you are
ignoring, so you don’t know how to adjust for its inadequacies.”

Now that the world has moved far beyond
any of the scenarios that the CDO issuers modelled, investors’ quantitative
grasp of the payouts has fizzled into blank uncertainty. That makes it hard
to put any value on them, driving away possible buyers. The trillion-dollar
bet on mortgages has gone disastrously wrong. The hope is that the
trillion-dollar bet on companies does not end up that way too.

Closing Jensen Comment
So is portfolio diversification theory dead? I hardly think so. But if any
lesson is to be learned is that we should question those critical underlying
assumptions in Plato's Cave before worldwide strategies are implemented that
overlook the Achilles' heel of those critical underlying assumptions.

A senior partner closed an investigation into a
£100,000 “bribe” despite colleagues suspecting the money had been paid to a
judge overseeing a multi-million-pound tax case the company was fighting.

The allegations were disclosed by former E&Y
partner and whistle-blower Cathal Lyons, who is suing the accountant for $6m
for breach of contract.

He claims medical insurance he was relying on to
treat injuries sustained in a car accident was withdrawn after he raised the
issue of the alleged bribe with the accountant’s global head office in
London.

Mr Lyons was a partner with E&Y’s Russian practice
when the alleged wrongdoing came to light. It was originally investigated by
James Mandel, E&Y’s general counsel in Moscow. In a witness statement
supplied in support of Mr Lyons’s case, Mr Mandel said he suspected the
payment may have been corrupt and wrote a report to that effect.

“I had the suspicion that this payment was not a
proper payment for legal fees, but was an illegal payment possibly made to
facilitate a positive outcome of a tax case,” he claimed in his witness
statement.

He suspected that the €120,000 payment via a
Russian law firm was made to influence a 390m rouble (£8.4m) court case
brought by Russian tax authorities investigating a tax avoidance scheme E&Y
was using to pay its Russian partners. E&Y was later cleared of liability in
the case.

The accountant has admitted there was an
investigation into allegations of bribery, but said the case was closed by
Herve Labaude, a senior partner, in January 2010.

Mr Lyons claims that after he reported his concerns
about the case to E&Y’s global head office, his medical insurance was
withdrawn and he was dismissed.

In his writ he says the dismissal flowed from
“personal animosity against him rising from a discussion in late 2010
between the claimant and Maz Krupski [E&Y’s director of global tax and
statutory] regarding alleged corruption by the practice.”

Mr Lyons relied on his medical insurance to cover
the cost of treatment flowing from a serious car accident he suffered in
2006. The accident left him with permanent disabilities and partial
amputation. It is estimated medical cover in his current condition would
cost $300,000 per year. He is suing for 20 years’ cover, or $6m.

An accountant accused of stealing more than a
million dollars from his company was found dead in his Irondequoit home on
Saturday.

Gary Yakawiak was suppose to be in court earlier
this month to be arraigned on a grand larceny charge, but when he didn’t
show up, the judge issued a warrant for his arrest.

When police showed up to search his house Saturday,
they found him dead inside. Police are not sure the cause of death at this
time.

This afternoon we spoke to the prosecutor in the
case.

Assistant District Attorney Mark Monaghan said. "I
don't know the nature or the circumstances of how he passed, but I'm sure
there are people who loved him and cared about him and it's unfortunate for
them that they're going to have to go through this period of loss."

Monaghan said either the court, the DA's office or
Yakawiak's attorney will make a motion to dismiss the indictment.

Yakawiak was accused of bilking $1.1 million
dollars from Cascades Recovery, a recycling company. He was the company’s
accounting manager. Police and the courts say that between August 2007 and
February 2011, he took chunks of cash from the company and tried to cover it
up by changing the bank statements.

Monaghan says there is now no recourse for Cascades
in state court. He said because there will be no conviction, there can be no
legal claim for restitution. If Cascades wants to get the money back that
Yakawiak was accused of stealing, it will have to do that through civil
court.